Megacap Tech Rally 2024 – Expert explains: What could cause the megacap stock bubble to burst

• Megacap stocks continue to drive a bull market in 2024
• Parallels to the technology bubble of the 1990s
• Possible catalysts for a reversal
Megacap stocks and especially the Magnificent Seven have caused a bull run on the stock market in 2023. This was largely fueled by the AI ​​boom that was started by OpenAI’s ChatGPT. Experts have repeatedly warned of a possible AI bubble, but even in the new year, which is now two months old, the megacap stocks are not yet running out of steam. But what if the megacap tech rally is actually a bubble?

Megacap stocks will also be bullish in 2024 – return to the mean?

As MarketWatch reports, there is currently intense debate about whether the rally has similarities to the tech bubble of the 1990s. “The ‘Magnificent Seven’ continue to drive U.S. stocks higher, sending index concentrations to record levels. A reversal in their fortunes could weigh heavily on the overall market,” Daniel Grosvenor, director of equity strategy at Oxford Economics, said in a note to MarketWatch is present. While Apple and Tesla, for example (-6.12 percent and -18.75 percent since the beginning of the year) have already stumbled this year, the leadership of the entire stock market rally has only become more concentrated (as of: closing prices on February 29, 2024).

Grosvenor noted that the index’s top 10 constituents have outperformed by a further three percent so far in 2024, after beating the broader S&P 500 SPX benchmark by nearly 30 percent in 2023. The top 10 now account for about 32 percent of the S&P 500’s total market capitalization, about 6 percentage points higher than the weight of the top 10 stocks at the height of the dot-com bubble in the 1990s, Grosvenor points out.

The vast majority of the top 10 is dominated by the Magnificent Seven, although Eli Lilly & Co. recently surpassed Tesla’s market cap, Grosvenor noted. He warned that the predominance of such a small number of companies and the high degree of correlation between them could reduce the index’s diversification benefits. This could mean that a decline in their wealth would have a significant impact on the overall market.

Additionally, he pointed out the tendency of the concentration in the index to revert to the mean. While this relationship appears relatively weak over a short time horizon, it requires a catalyst to trigger the reversal.

In the statement, Grosvenor listed some possible candidates who could act as such a catalyst.

Expectation of profit leaves room for disappointment

The mega-cap companies continue to show strong earnings growth overall, which means that the gap to the rest of the market is also widening. This year, however, it will be much more difficult for companies to exceed analysts’ expectations, explains Grosvenor.

After comfortably beating expectations for 10 percent profit growth last year, the Magnificent Seven is forecast to post a further 22 percent increase in 2024 – assuming profit margins reach a record high. Despite this forecast, the analyst is skeptical and argues that while AI advances could help further increase profitability in the medium term, there is already significant upside potential.

“That leaves room for disappointment,” Grosvenor wrote, pointing out that history shows that it takes a long time to realize the benefits of technological change and that there is no guarantee that “these particular companies will be the ultimate winners will be”.

Excessive valuations and rising bond yields

Grosvenor also stressed that valuations for the Magnificent Seven appear stretched again, with the group now trading at an average 12-month price-to-earnings ratio of 29, compared to 16 for the rest of the S&P 500 well above the decade average and is now above the post-pandemic average.

This was despite bond yields also being well above average, which tends to impact stocks whose high valuations are based on earnings expectations far into the future. That makes this part of the market more vulnerable to a correction if inflation proves to be more persistent than expected in the future and bond yields continue to rise in the short term, he said.

Grosvenor pointed out that the Magnificent Seven underperformed in 2022 despite the initial significant rise in Treasury yields. In the third quarter of the previous year, despite solid earnings performance, they struggled to outperform the broader market as yields rose sharply.

Political environment

Added to this is the challenging political environment, says Grosvenor. There will be a controversial US presidential election in November, which would increase the prospect of “political uncertainty”, which could particularly impact sophisticated stocks.

Grosvenor says the tech sector will continue to be in the spotlight from an antitrust perspective, which will likely be a key campaign focus for Democrats.

The Magnificent Seven could also face increasing uncertainty over trade policy, the analyst said. A worrying point given that as a group they generate a much higher proportion of their revenue outside the US than the broader S&P 500. These companies also have significant exposure to, for example, China and Taiwan. In recent years, their relative returns have been negatively correlated with measures of trade uncertainty.

However, it remains to be seen whether one of the possible catalysts will actually trigger a correction.

Editorial team finanzen.net

This text is for informational purposes only and does not constitute an investment recommendation. finanzen.net GmbH excludes any claims for recourse.

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