The 'Magnificent Seven' aren't seven. Or magnificent.

By Brett Arends

Time and again investors discover a small group of stocks or investments that supposedly can't fail. Is this time different?

And then there were four.

Tesla (TSLA) is down this year by double digits. Apple (AAPL) is down. Microsoft (MSFT) has been lagging behind the S&P 500. Of last year's hot fad, the "Magnificent Seven" tech behemoths, only four continue to make bank.

And of those one, Meta (META), has had a bad couple of weeks.

Artificial-intelligence computer-chip Nvidia (NVDA) is the only one whose stock is still looking "magnificent." It's risen nearly 80% since the start of the year. Booyah!

We have been here before. Time and again investors have discovered a small group of stocks or investments that supposedly can't fail. During the last tech mania, back in 1999-2000, there were also four. They were called The Four Horsemen. The name comes from the apocalypse, in the Book of Revelation.

Given what happened next, you have to figure Wall Street has a secret sense of irony.

From the end of January 2000 through the end of January 2010, Microsoft investors lost 28% of their money - including dividends. And we are not counting fees, taxes on dividends, or the cost of missing out on other, more profitable investments while you are sitting on a losing stock.

And of the Four Horsemen, Microsoft was the winner. Investors in chip maker Intel (INTC) lost just over 50%. Investors in Cisco Systems (CSCO), ditto. And those in Dell (now relisted as Dell Technologies) (DELL) lost an eye-watering 74%. You started with a dollar, and 10 years later you don't even have a quarter.

Average return for the Four Horsemen over that period: Minus 52%.

Granted, this period - early 2000 to early 2010 - was one of the worst decades on record for the entire U.S. stock market. Nonetheless, the Four Horsemen managed to underperform the S&P 500 SPX index of large-cap stocks by a country mile. The S&P was down about 6% over the same period.

The Vanguard Total Stock Market Index Fund VTSAX, which invests in small and midsize companies as well as large-caps, eked out a 1% gain. Global stock markets, as measured by the MSCI All Country World Index (ACWI), gained just over 10%.

These aren't isolated incidents. In 2010 the fad was for the so-called BRIC emerging markets, meaning Brazil, China, India and Russia. Over the next 10 years, they produced one-third of the returns of the global ACWI index. (Russia has since been canceled altogether.)

The early 1970s was famous for the "Nifty Fifty" of high-tech growth stocks that couldn't fail. Like, er, Polaroid, Kodak, Digital Equipment and Xerox.

How's your Polaroid stock doing?

(To be fair the list also included companies like Coca-Cola (KO) and Procter & Gamble (PG).)

Fund manager Howard Marks, writing nearly 50 years after the Nifty Fifty peaked, recalled that at the time they were considered so good that "nothing bad could happen to them" and "there was no price too high" for their shares."

The stocks did very well for a while. Then they did very badly - for years. If you held on long enough, Marks added, about half of them ended up earning "respectable returns," even from the peaks. But that's only half. And by "long enough" he meant decades.

What of today's Magnificent Seven (or, if you prefer, the Magnificent Four)?

At current stock-market valuations, these seven companies alone account for about 28% of the total value of the entire S&P 500. And just the Magnificent Four account for 15%.

In aggregate, they are valued at $14 trillion, or about 50% of total U.S. gross domestic product.

Most of them have stocks trading between 20 and 40 times the forecast per-share earnings. These are generous valuations, especially in an era when you can earn 5% just sitting in Treasury bills.

Tesla: 70 times earnings.

Meanwhile the S&P 400 index of mid-cap stocks trades on an average of 15 times earnings.

Yet according to FactSet, not one analyst on Wall Street has an outstanding "sell" or even "underweight" rating on Microsoft, Alphabet (GOOGL), Amazon (AMZN)or Nvidia. Negative recommendations account for just 3% of all recommendations on Meta's (META) stock, and 9% on Apple. For Tesla, though, the figure is nearly 20%.

In the short run, the only stock-market forecast worth a damn is the one supposedly offered by J.P. Morgan Sr. over 100 years ago. "Share prices will fluctuate," the banker allegedly said to a reporter.

In the long run, for those enamored of the tale of the Magnificent Four, here are two points to consider.

First, fund manager Wellington calculates that U.S. small-cap stocks "have not been this undervalued relative to large-cap stocks since the dot-com bubble."

Over the 10 years following the peak of the dot-com bubble, small U.S. stocks crushed large-caps. The MSCI index of small and midsize U.S. stocks generated a total return of just under 40% (despite two epic stock market crashes). The MSCI index of large-cap U.S. stocks over the same period? Minus 20%.

Second, Ben Inker and John Pease at fund management firm GMO have crunched the numbers on the S&P 500 going back to 1957. They have found that over that time there have been three periods when the 10 biggest stocks produced higher returns than the other 490: The late 1960s, the late 1990s, and recently. For the rest of the time, it's been the other way around: You wanted to own the S&P 490, not the S&P 10.

Overall, despite the recent boom in mega caps, the 490 have beaten the top 10 stocks over the long term by an average of 2.4 percentage points a year. That's equivalent to about 20% of the S&P 500's average annual return.

Maybe this time around will be different from all the previous times. Or maybe not.

-Brett Arends

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04-30-24 1344ET

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