Too Much Value Concentrated in Seven US Stocks

Recently, the UK chip design firm ARM (NASD: ARM) had a successful IPO on the Nasdaq. It could possibly join the seven stocks that compose most of the value of the US stock market. Jim Cramer of CNBC used to call the tech stocks who led the market FAANG (Facebook, Amazon, Apple, Netflix, Google), but now he has a new group.

Cramer says that the “Magnificent Seven” stocks that now lead the market are Apple, Microsoft, Nvidia, Amazon, Meta, Tesla and Alphabet. If the market agrees, ARM may be part of that in the future.

Market valuations change regularly, of course. But as of mid-October 2023, the seven tech stocks had a roughly $11.1T combined market cap valuation out of a total $37.5T market cap for the 500 companies or almost a third of the entire index. The largest of these seven is Apple (NASD: AAPL) at around $2.8T, and not so far behind is Microsoft (NASD: MSFT) at $2.4T. (Please note that stock valuations change daily and these are approximate at the time of writing.)

According to a June 2023 FT article, Apple was worth more than all the Top 100 UK-listed companies combined, and worth more than the entire Russell 2000 index.

To say that the US markets are top-heavy is an understatement. While the S&P 500 index moves forward because of the Magnificent Seven, the remaining 493 companies in the index are essentially flat.

The problem with this is that while the S&P 500 and the NASDAQ appear to be healthy because of the spectacular performance of these seven, in reality, what it does is mask the underperformance of most of the other 493. Not all, of course, but many companies are struggling.

Many of these Magnificent Seven tech companies have very high price-to-earnings (P/E) ratios, meaning that their price is a large multiple of their current earnings per share. Thus large P/E ratios, such as 105 for Nvidia, mean that the price is 105 times the current earnings per share. This is due to forward speculation on the future of the technology, in this case, artificial intelligence (AI) since Nvidia is integral to the growth of that—in my opinion, overhyped—sector.

Unfortunately, in terms of employment, most Americans do not work in chip design and manufacturing or AI software development. Millions are employed in traditional sectors, such as retail, banking, healthcare, insurance, real estate, food and beverage, consumer care, petroleum and energy, and other industries.

Personally, I am in the real estate space, a sector that relies heavily on debt financing. With high interest rates, it becomes more expensive for people to buy houses on new thirty-year mortgages. It becomes harder for real estate developers to attract financing. The ten-year US bond is approaching 5%. When the ten-year bond has a high yield, fewer investors are willing to finance risky ventures and prefer instead to keep their money in these instruments.

In other traditional sectors, a lot of the small- and medium-sized companies in the Russell 2000 are barely making it. Many of them are just earning enough to pay their employees and service their current low-interest debts.

Unfortunately, when their older, lower-interest debts mature, these struggling companies will likely be faced with higher interest rates on their debt. Many of them will simply declare bankruptcy.

Thus, in my opinion, it is unfair for the Fed to simply use the S&P 500 index that is being pulled up by the Magnificent Seven as one basis for hiking rates. Most tech companies are funded by equity, not debt. Traditional companies have a larger debt component, especially sectors such as real estate, which are currently in tempestuous times. Debt is now expensive, and these debt-dependent industries are feeling the pinch.

Many Americans right now have depleted their personal savings accumulated from the pandemic CARES Act and are starting to max out their credit cards. Credit card debt interest now exceeds 20%, and the total credit card debt now exceeds $1T. Inflation currently driven by high energy prices have made groceries, gas, transport, and utilities more expensive. Unfortunately, home mortgages are now at a 7.5% interest rate, car loans are high, and student loans resumed in October 2023. More bankruptcies, and more job layoffs, will definitely impact many lives in a bad way.

For those business leaders who are in the same boat as the Russell 2000 companies, the main advice I can give at this time is to cut unneeded costs, cut down on asset holdings of small cap stocks, move more money into fixed income instruments like US treasury bonds, avoid aggressive moves in terms of expansion or strategic shifts for the moment, and hope for the best in these uncertain times.

While the Magnificent Seven is a source of pride and a major source of US GDP, the current dominance of tech in the markets also distracts us all from the real economy’s true performance. It is unfair to most Americans if the Fed is using the high-flying stock markets as justification for further rate hikes especially since many industries are barely above water these days and are in danger of declaring bankruptcy and laying off their employees.

The information provided here is not investment, tax, or financial advice. You should consult with a licensed professional for advice concerning your specific situation.