As we step into a new year, it's worth noting that the same old stocks continue to capture our attention. Surprisingly, this can be seen as a positive sign for the stock market.
These seven particular stocks hold more than a quarter of the S&P 500, making them significant weighted contributors to the overall market capitalization. Consequently, their impressive rallies have propelled the entire index to new heights. However, it wasn't until the November rally that most other stocks began to join the party.
Initially, there were concerns among strategists about relying heavily on this small group of megacap winners. They feared that if this group faltered, it would have a negative impact on the overall stock market. However, according to Benson Durham, Piper Sandler’s head of global policy and asset allocation, these fears are largely misplaced.
Durham's research indicates that these Magnificent Seven stocks do not usually move in unison, and including them in the S&P 500 actually reduces volatility in returns. This trend is expected to continue in 2024, affirms Durham in a Tuesday research note. He argues that investors need not worry about bigger swings in the index due to the outsized role these seven companies play.
Specifically, Durham employs a statistical model called GARCH (generalized autoregressive conditional heteroskedasticity) to measure volatility. Excluding the Magnificent Seven, he found that volatility in returns for the S&P 500 stands at 10.9%. However, when these tech titans are included, the volatility decreases to 10.5%. According to his projections, this difference is expected to be 0.4 percentage points by 2024.
In essence, while each of these seven stocks may have higher individual volatility compared to the index as a whole, their correlations with one another remain relatively modest. This absence of lockstep movement ensures that the index is not overly concentrated, mitigating any potential increase in risk.
Durham further asserts that these Magnificent Seven stocks offer a level of diversification similar to investing across various sectors.
Overall, the extraordinary influence of these stocks does not translate into supersized risk. The math backs this claim, as Durham explains. Therefore, it seems the same old stocks taking the spotlight should be viewed as a promising aspect of the stock market's landscape.
Again, utilizing a GARCH model, it has been determined that the average dynamic correlation among the daily returns of pairs of Magnificent Seven (M7) stocks remains lower than that among sectors in the S&P 500. The correlation among the big tech stocks stands at approximately 0.41, compared to 0.496 for the sectors.
A higher correlation suggests a greater likelihood that assets will move in the same direction. This implies that the eleven individual S&P 500 sectors trade in tandem slightly more frequently than the Magnificent Seven.
Moreover, an analysis conducted by Durham reveals that around 51.2% of the M7's variance, which is defined as their squared volatility, is derived from one dominant factor. Similarly, the most prominent common dynamic factor accounts for roughly 52.3% of the variation across S&P 500 sector returns. Consequently, investing in M7 stocks does not expose one to any more common factors compared to investing across the range of S&P 500 sectors.
This highlights that, contrary to intuition, the M7 stocks are not significantly riskier in terms of volatility than the broader industry sectors within the S&P 500, despite the latter encompassing a greater number of companies.
Although this may provide little solace to investors as the new year began with each of the Magnificent Seven stocks trading lower, Tesla managed to flirt with small gains by early afternoon. Only Apple bore the burden of a 3% decline after being downgraded to start off 2024.
While Durham believes investors should not avoid the Magnificent Seven this year in an attempt to mitigate risk, others argue that there are additional reasons to remain invested. Technical analysts and strategists advocate for big tech, and various fundamentally focused research indicates further gains for companies revolutionizing artificial intelligence technology. This includes both smaller tech names and the M7.
In summary, just as 2023 brought about an unexpected rally, 2024 is expected to bring plenty of surprises. Therefore, concerns regarding the role of the Magnificent Seven should be alleviated. It appears that the tech party is far from over.
Our Latest News
Advanced Micro Devices Exceeds Expectations with Strong Profit in Q4
Advanced Micro Devices (AMD) exceeds expectations in Q4 with a profit of $667 million, driven by AI demand. Revenue reaches $6.17 billion. AMD predicts Q1 reven...
President Biden Expresses Support for UAW Strike
President Biden expresses support for United Auto Workers' strike against Big Three automakers, highlighting the need for fair contracts and equitable distribut...
RumbleOn Appoints Harley-Davidson Executive as New CEO
RumbleOn has appointed Michael Kennedy, former Harley-Davidson executive, as its new CEO. Kennedy brings 25+ years of experience and will also join the board of...