The Magnificent Seven (Mag 7) trade, which includes tech giants like Meta (META), Amazon (AMZN), Google (GOOG), Apple (AAPL), Nvidia (NVDA), Microsoft (MSFT), and Tesla (TSLA), has been a cornerstone of many investment strategies in recent years. However, with the trade struggling just two months into 2023, investors are being urged to rethink their exposure to these stocks before the situation worsens. Adam Parker, founder and CEO of Trivariate Research, has been a long-time advocate for maintaining a market-weight position in the Mag 7. But in a recent note, he revealed a significant shift in his stance, advising investors to reduce their exposure to these tech heavyweights. Parker’s reasoning is rooted in three key concerns: the escalating scrutiny over capital expenditures (capex) related to AI investments, the persistent premium valuations of these stocks, and the elevated beta-adjusted exposure of the Mag 7 in investor portfolios.
One of the primary drivers of the sell-off in Mag 7 stocks is the growing concern over the massive capital expenditures being incurred by these companies, particularly in their pursuit of artificial intelligence (AI) capabilities. Meta, Microsoft, Amazon, and Alphabet are expected to collectively spend $325 billion on capex and investments in 2023 alone, as reported by Yahoo Finance’s Laura Bratton. This figure represents a staggering 46% increase from the previous year. Amazon, for instance, is projected to spend $104 billion on capex, far exceeding earlier analyst estimates of $80 billion to $85 billion. Parker points out that such bold spending commitments have historically led to negative reactions from the market, as investors struggle to reconcile the high costs with the uncertain future returns on these investments. He warns that the Street’s focus on these expenditures is unlikely to waver, particularly as we approach 2025 and 2026, when the financial impact of these investments will become more evident.
Another critical factor weighing on the Mag 7 is their elevated valuations, which remain a cause for concern despite the recent underperformance of these stocks. Parker’s research highlights that the relative price-to-forward-earnings multiple of the Mag 7 compared to the rest of the S&P 500 stands at a 42% premium. This places the metric near the upper end of its 25-year average, suggesting that these stocks are still priced at a significant premium relative to the broader market. Parker cautions that the combination of high beta, increasing capital intensity, and elevated valuations makes the Mag 7 a increasingly risky proposition for investors. He emphasizes that while these companies have historically justified their premium valuations through strong performance, the current environment may not be as forgiving, especially if the market begins to question the sustainability of their growth trajectories.
The third reason Parker is urging investors to trim their exposure to the Mag 7 is the sheer size of their presence in investor portfolios. The aggregate market capitalization of these seven companies accounts for 31.3% of the S&P 500, meaning nearly a third of the market’s opportunity is concentrated in these stocks. When adjusted for beta, which measures a stock’s sensitivity to market movements, the exposure is even more pronounced. Parker notes that the beta-adjusted exposure of the Mag 7 currently stands at 44.7%, meaning that a portfolio manager holding these stocks at market weight effectively has almost half of their fund’s beta-adjusted exposure tied to these seven companies. This level of concentration is near historic highs, and Parker argues that such elevated exposure could amplify losses if the market continues to sour on these stocks.
Beyond these three primary concerns, there is an additional warning sign that Yahoo Finance uncovered while analyzing Parker’s research. The Mag 7 stocks are overwhelmingly favored by Wall Street analysts, with only 4.8% of the 504 analyst recommendations on these companies being a “Sell.” While this level of bullishness might seem encouraging at first glance, it also suggests that there is a disconnect between the optimistic views of analysts and the reality of the market. Should the investment thesis behind the Mag 7 begin to unravel, this uber-bullishness could prove to be misplaced, leaving investors exposed to significant downside risk. Parker’s warning serves as a timely reminder that even the most seemingly invincible stocks can fall out of favor, and investors must remain vigilant in reassessing their positions.
In conclusion, the once-mighty Mag 7 trade is showing signs of strain, and investors would do well to heed Parker’s advice and consider reducing their exposure to these stocks. The combination of escalating capex, premium valuations, and overownership creates a Perfect storm of risks that could lead to further declines in the coming months. While the Mag 7 have been the driving force behind the market’s gains in recent years, the current environment suggests that it may be prudent to diversify away from these heavyweight tech stocks. As the market continues to grapple with the implications of their massive AI investments and elevated valuations, investors would be wise to adopt a more cautious stance and reevaluate their allocations to these once-reliable performers. After all, even the most successful trades eventually reach a point where it’s time to take profits and reassess the landscape.
