Stocks: is the bubble about to burst? No (and I'll explain why)

At the end of February, the market capitalization of the group of “magnificent 7” in the SP500 index exceeds almost all the entire capitalizations of the individual indices of stock exchanges scattered around the world.
Should we worry? Absolutely not.
The dizzying increase in profits and market capitalizations of the Magnificent 7 group, i.e.
the US technological giants – Apple, Amazon, Google, Meta, Microsoft, Nvidia and Tesla – caused the capitalizations of every index to exceed, as of February 18th stock market in the world, excluding the SP500 index.
I went to read a report dated February 13th from Deutsche Bank, basically a study prepared for its clients (Jim Reid: “A Macro Guide to the Magnificent Seven”, Deutsche Bank Research) which cannot be disclosed but which you can find in summary also here: The Mag 7 are so big they're not just companies, they're countries in size and scale – DB.
However, the "supremacy" of the Magnificent 7 group does not only concern capitalization, but also concerns the cumulative profits of the group in 2023, compared to the cumulative profits in the same year of companies listed on every non-USA international stock exchange.
Their profits are large but not that gargantuan: At $361 billion over the past 12 months, they are slightly less than the $383 billion grossed by all Japanese companies in 2023 and about half of Chinese ones, over the same period.
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This fountain of profits allows us to affirm that this time we are not in the presence of speculative bubbles, as in the year 2000, when companies that closed their balance sheets at a loss or with very weak profit growth rates saw their prices grow dramatically with P /And over 40x.
Stock prices have risen because earnings have risen, and with them, so have expectations of higher profits in the future, and despite the fact that yields on 10-year Treasuries today are around 4.30%.
Deutsche Bank analysts have underlined that if a list "reserved" only for the Magnificent 7 were created, the combined market capitalization of this small group alone would make it the second largest stock exchange in the world, with a size similar to that of the Dow Jones index.
Below are the numbers – recorded as of February 19th.
CAP STOCK IN BILLION $ MICROSOFT 3,000 APPLE 2,800 NVDIA 1,800 AMAZON 1,770 GOOGLE 1,750 META 1,200 TESLA 640 TOTAL 12,960 As you can see above, we are talking about almost 13 trillion dollars.
Numbers that make your head spin.
The group of 7 capitalizes a little more than the Dow Jones index (12,240 billion dollars) and almost 30% of the entire SP500 index, and over 10 times the capitalization of the DAX (1,720 billion dollars) and 17 times the capitalization of the Italian index (our FTSE MIB 40 capitalizes only 700 billion dollars).
As you will notice from the list above, if we take Microsoft and Apple, individually, they have market capitalizations larger than the entire DAX index or the CAC40 index, and, of course, the entire British FTSE 100 index ($2,560 billion).
This level of concentration of stock value in a narrow group of stocks has led some analysts to express concerns about related risks in the U.S.
stock market.
Deutsche Bank also analyzed the current situation from a historical point of view and studied the trends of all 36 companies that were – cyclically – among the top five most valuable in the S&P 500 index, year by year, since the mid-1990s.
60 to date.
Generally speaking, while large companies ultimately tended towards a certain mobility within the group, that is, to enter and exit the group of the top five (due to the evolution of investor trends, new consumption trends and of profit) they still remained market leaders in their product sector.
And those who are market leaders constantly tend to reward their shareholders with good dividends, and maintain high popularity on the stock exchange: 20 of the 36 companies that populated that upper band in terms of capitalisation, after more than 60 years, are still today among the top 50 of the SP500 index by market capitalisation.
For example, in the Magnificent 7 group, the first 5 stocks are now present in the current top 5 of the largest capitalization stocks, obviously.
Well if we take Microsoft, it has been present for all the months – except 4 months – from 1997 to today.
Apple has always been present since December 2009, Alphabet for all months – except two – from August 2012 to today, and Amazon has always been present from January 2017 to today.
The last "competitor" in the group of 5 was Nvidia, a "new entry" that has been present "only" since the first half of last year.
Tesla was among the top five most valuable companies for 13 months in 2021/22, but has now fallen to 10th place, with the share price down around 20% since the start of 2024.
In contrast, Nvidia stock continued to rise, adding nearly 47% since the beginning of the year.
So, within the Magnificent Seven group there is some volatility regarding the position of its members, and one can question whether their overall valuations have reached excesses, but the core of the group is the largest companies by turnover and the most successful ones in the United States and in the world, for many years now, especially following the phenomena of globalization.
Despite the subdued global economic outlook at the start of 2023, stock market returns on Wall Street have been impressive, but heavily concentrated among the Magnificent Seven, which have benefited from AI hype and rate cut expectations.
Anyone who had invested in January 2023 in the Magnificent 7 alone would have taken home an incredible +107% as of December 31, 2023, far outpacing the broader MSCI USA index, which offered investors a still honest, but relatively paltry , +27% in 2023.
But now things are changing.
Signs are emerging that opportunities for US stocks could broaden beyond the 7 mega-cap stocks this year, and for two reasons, the first of which is the resilience of the US economy.
In fact: despite the increase in interest rates, company sales and profits have shown good stability, at least when looking at the quarterly results that are coming out these days, relating to the last quarter of 2023.
This can be attributed to the fact that the businesses were more disciplined in managing costs and inventories, and that families continued to consume and spend despite the increased cost of money, because they had accumulated higher levels of savings during the 2020-2021 pandemic.
Furthermore, despite the fact that Fed rates were brought from 0% to 5% in just over 1 year, unemployment actually dropped to 3.7%: the US labor market is therefore in good health, with almost three million jobs of jobs added in 2023 which contribute to keeping consumption levels high in America.
The second factor is improving margins, which indicates that companies have cleverly increased prices and passed on the impact of higher inflation to customers, without customers decreasing their spending decisions.
In the presence of consumer demand that is inelastic with respect to the price level, companies have been able to maintain profit margins and present themselves to investors with more than satisfactory balance sheet results.
But the trend of improvement in profit margins began in the early 90s, as you can see from the graph at the end of the article, drawn up thanks to BLOOMBERG, which highlights the constant growth in profitability (understood as gross profits divided by turnover) of the SP500 index.
In 1992, profitability was around 4% on average for the companies that made up the basket of 500 companies.
In December 2023 we reached 13.6%, therefore more than tripled compared to 30 years ago.
It is common opinion that this upward trend must undergo a further surge in the coming years thanks to the advent of Artificial Intelligence which will be better able to enhance productivity per employee and reduce labor costs per unit of product, in my humble opinion .
n summary: Although wages increased in 2023, they did not keep pace with rising prices, leading to a decline in labor costs as a proportion of the selling price of goods and services.
This is a virtuous circle that makes the question of “WHEN” the Fed will decide to cut rates obsolete, because corporate profitability is so strong that, for the moment, it can afford to wait for the Fed to cut rates in July and no longer in March: the next 2 quarters are also expected to be solid for the American corporate system.
This is why we shouldn't worry that the stock market capitalization is so concentrated within the SP500: the market has rewarded the best companies in getting on the "bandwagon" of technological innovation and producing profits, and it has done well.
When the market is so heavily weighted towards a limited number of stocks and towards a particular theme, particularly artificial intelligence, there is a risk of missing out on investment opportunities.
Every market reversal will be an opportunity to enter the market, as I have already had the opportunity to underline for the readers of the Money Premium section in this recent article of mine: Shares: from today every market reversal can be an entry opportunity (money.
it).
Indeed, there is another factor to add that should convince us to remain invested for 2024: sector rotation.
Factors including China's accession to the World Trade Organization and technological advances have enabled greater labor supply and accessibility to foreign labor markets.
Even for companies outside the Magnificent 7 group.
This has helped improve profit margins, supporting earnings growth.
It is therefore possible that the rally of the sp500 index may be supported not only by the group of 7 but, when the Fed begins to cut rates, also by smaller capitalization companies.
Many of the other 493 stocks in the S&P 500 have struggled over the past year, but some say they could begin to join the rally if the two factors mentioned above (economic resilience and corporate margins) continue to fuel the economy in the second half of 2023 DISCLAIMER The information and considerations contained in this article should not be used as the sole or principal support on which to make investment decisions.
The reader retains full freedom in his own investment choices and full responsibility in making them, since he alone knows his risk propensity and his time horizon.
The information contained in the article is provided for informational purposes only and its disclosure does not constitute and should not be considered an offer or solicitation to public savings.