'Magnificent Seven' Dominate S&P 500, But Haunting Echoes Of Dot-Com Bubble Resurface

A small group of stocks has seized the limelight on Wall Street, challenging the widely held belief that gains in the U.S. stock market are a dime a dozen.

Seven tech giants, to be precise, have surged by a jaw-dropping 100% or more year-to-date, leaving the rest of the crew in the dust.

If you had the smarts to put together a portfolio with these seven big shots at the start of the year—Apple Inc. AAPL, Microsoft Corp. MSFT, Alphabet Inc. GOOG GOOGL, Amazon Inc. AMZN, Meta Platforms Inc. META, NVIDIA Corp. NVDA, and Tesla, Inc. TSLA—your investment would now have doubled in size.

Now, if you went the traditional route and stashed your cash in the broader SPDR S&P 500 ETF Trust SPY, you’d still be enjoying with a decent 17% return. But, you’d still be way behind the tech giants’ jaw-dropping gains.

And for those who thought a rising market would lift everyone’s boat, it’s time for a reality check. The Invesco S&P 500 Equal Weight ETF RSP barely moved the needle with a modest 4% gain this year, failing to capture the explosive growth seen in the tech sector.

Here’s the real shocker: if you were to exclude these seven stock marvels from the S&P 500 index, you’d be staring at negative returns for the remaining 493 companies in the index since the year began.

This underscores the overwhelming influence this elite group wields in shaping stock market fortunes this year.

Chart: ‘Magnificent Seven’ vs. S&P 500, Equal-Weight S&P 500, and S&P 493 – YTD Performance as of Sept. 12, 2023

Factors Driving Tech Stocks

The meteoric rise of these tech titans is, in large part, attributed to the transformative power of artificial intelligence (AI).

In the wake of a challenging 2022, these companies have harnessed the potential of AI to navigate turbulent waters, emerging not only unscathed but fortified for the journey ahead.

Adding momentum to the tech fervor is the noteworthy decline in the Consumer Price Index (CPI), which has descended to a mere 3.2% according to the latest July data.

This dip has buoyed expectations that the Federal Reserve may soon hit the brakes on its ongoing series of interest rate hikes, further fueling optimism within the tech sector.

Warning Bells Toll For Tech Stocks

The unassailable reign of tech stocks has started to raise concerns about the sustainability of their gains, evoking memories of the dot-com bubble era.

A glaring sign of this tech-centric surge is the Nasdaq 100’s current valuation compared to that of small-cap stocks, a metric that has now exceeded the peak levels witnessed during the dot-com bubble.

Data sourced from Market Chameleon paints a stark picture: the price-to-earnings ratio (P/E ratio) of the Invesco QQQ Trust QQQ ETF stands at a staggering 35.02.

To put it simply, if we were to assume that the tech sector’s earnings over the past 12 months remained constant indefinitely, it would take an investor a whopping 35 years to recoup their initial investment.

This eye-popping number doesn’t just edge past the three-year average of 30; it also overshadows the five-year average of 28. In simple terms, tech stocks are now 15% more costly than they have been over the last three years and a hefty 24% pricier compared to their typical valuation in the last five years.

This speaks volumes about how the market has already priced in exceptional growth when it comes to valuing tech stocks.

Table: QQQ Valuation Metrics and historical comparison

QQQ Valuation Ratio	Current	3-Year Avg	Current vs 3-Year Avg (%)	5-Year Avg	Current vs 5-Year Avg (%)
P/E	35.02	30.44	+14.98%	28.23	+23.85%
P/Sales	4.40	4.28	+2.80%	3.89	+13.64%
P/Cash	31.62	32.32	-2.17%	29.25	+8.16%
P/Book	7.21	7.04	+2.41%	6.40	+12.97%
P/Tangible Book	14.69	15.07	-2.52%	14.10	+4.26%
P/EBIT	26.13	23.66	+10.44%	21.80	+19.88%
P/EBITDA	18.44	16.74	+10.16%	15.35	+19.90%
P/Operating Income	25.75	23.63	+8.97%	21.78	+18.37%