The Magnificent 7: A cautionary investment tale

As a group, these companies have been riding high. But looks can be deceptive.

In the 1960 Western movie  The Magnificent Seven,  a group of American gunmen help defend a small Mexican village from being pillaged by a gang of ruthless bandits.

It was a box-office hit, ultimately leading to three sequel movies, a TV series, a remake in 2016, and to the movie studio Metro-Goldwyn-Mayer last year announcing it was adapting a new TV show based around the original film.

The catchy movie title seems to have stuck over the last 64 years, and right now there’s an alternative “Magnificent 7” hero bunch that’s garnering even greater attention, on a global scale.

It features an all-star, eclectic cast of mega-cap technology stocks — Alphabet (Google), Amazon, Apple, Meta, Microsoft, Nvidia and Tesla – which at 16 April had a combined market value of US$13.5 trillion (A$21 trillion).

Collectively, the “Magnificent 7” returned more than 106% in 2023, fuelled by investor hype over their direct or peripheral involvement in the development and use of artificial intelligence (AI) technologies.

Based on their market weightings, the seven stocks have been the main drivers behind the big gains recorded on United States’ share markets over the last 16 months. In 2023 they spurred the Nasdaq Composite and S&P 500 indexes to gains of 37% and 24%, respectively. Year-to-date, again largely thanks to strong investor demand for the “Magnificent 7”, the Nasdaq and S&P 500 are up 7.4% and 6.5%, respectively (as at 16 April).

Behind the scenes

As a group, the “Magnificent 7” stocks have on average gained around 18% in market value over the course of this year.

Yet, on an individual level, only five of the seven are currently outperforming the broader U.S. share market – three of them by very substantial margins and two by more modest percentages. But two of the seven are significantly underperforming the market, leading some commentators to speculate that the “Magnificent 7” could soon need to be rebadged.

Keeping with catchy labels, a number are now even referring to the strongest of the “Magnificent 7” tech stock performers as “The Fab Four” – a tag generally linked to music band The Beatles.

Only time will tell if the “Magnificent 7” endures as a high-flying group, but herein lies an important lesson for investors. Chasing hot market trends often carries a heightened element of investment risk.

Investment trends don’t necessary last, and future potential trends may never eventuate. Strong demand for a real or perceived trend can artificially inflate market prices.

Fear of missing out (FOMO) on an investment opportunity is a key behavioural driver for many investors. Yet, trendy investments and products don’t necessarily have long-term staying power.

That’s because investment trend seekers often decide to take out their profits early and move on to something else, which can then trigger a significant downturn in the investments that they sell.

The importance of being diversified

Investing in a theme, or a group of stocks exposed to a particular trend, may deliver good upside performance over a short period, but equally there can be significant downside exposure risks.

How you allocate your investment capital can be one of the most important, and often difficult, decisions.

Your asset allocation strategy should always be in tune with your investment goals and your tolerance for taking risk.

If you invest in a single company, you’re basically only buying into that company’s operations and the particular sector in which it operates.

Investing in a few companies can provide you with some diversification, unless all of those companies are operating in the same market sector.

Alternatively, one investment in a broad-based index fund, such as exchange traded fund (ETF) will provide exposure to hundreds and sometimes thousands of companies operating in many different markets and sectors.

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