The Magnificent Seven: Tech Stocks Bubble

The hot Magnificent Seven group of stocks may be in a mini bubble, one that’s about to pop.

The silver lining is that, once they do, investors should probably scoop up the shares. 

Stock Surge and Bubble Burst

The Seven, which include Nvidia, Microsoft, Meta Platforms, Alphabet, Tesla, Apple, and Amazon.com, have seen stock prices surge in the past few months. Some have more than doubled from their bear-market bottoms, with Nvidia up more than sixfold.

The major driver has been new opportunities for artificial intelligence as the technology shifts from Google’s large language model “Gemini,” to new and advanced cloud-computing capabilities. Investors see more market opportunity for the technology behemoths. Analysts have increased their profit forecasts for the Seven companies, driving the stocks higher. 

Now, the group looks too hot—and evidence is building that the Seven is in a bubble that’s starting to burst.

Signs of a Bubble

The first piece of evidence is that the share-price gains are on par with those seen in other bubbles. The “FAANG stocks”—a predecessor group to the Seven—in aggregate, rocketed 229% by 2021 from their lows, before falling 49%, according to Bank of America. Before that, dot-com stocks soared 192% by 2000, and then plunged 73%. 

The next question is when these parties tend to end. Nine out of 14 bubbles that BofA studied burst after less than two years of declines. So far for the Seven, the run has lasted just over a year, so they could falter soon.

Market Saturation

To that point, so much money has recently rushed into the seven stocks that not much more can move in. Just over a net $10 billion has flown into tech stock funds this so far year alone, putting the inflow on pace to hit $84 billion for the entire year. That would be a record, and about double last year’s $44 billion inflow.

The Tech Stocks Conundrum: A Baby Bubble or a Bull Run?

Recent fluctuations in the tech stocks market have raised concerns about the future growth prospects of this sector. With new buyers potentially on the sidelines and existing investors hesitant to take on additional risks, the once high-flying tech stocks have experienced a modest retreat, exemplified by Nvidia's 7% dip. The primary trigger for this pullback was last week's unexpected rise in inflation, leading to an increase in long-dated bond yields. These higher yields diminish the appeal of future tech company profits, as many of these companies are valued based on the expectation of substantial earnings in the distant future.

Is the AI-hype Rally Just a "Baby Bubble"?

Bank of America (BofA) has labeled the recent surge in AI-related stocks as a "baby bubble," cautioning against immediate investments in this volatile environment. While the current sentiment points towards a wait-and-see approach, it also presents a potential opportunity to capitalize on any significant market downturn.

The Long-Term Bull Case for Tech Stocks

Despite the short-term uncertainty, the long-term outlook for the tech sector, particularly AI-focused companies, remains promising. The growth potential within the AI market is undeniable, with projections suggesting nearly 20% annual growth in AI spending through 2032, reaching over $2.5 trillion. This projection bodes well for tech companies at the forefront of innovation, hinting at sustained or even accelerated earnings growth in the coming years. As these firms navigate their cost structures, stabilize profit margins, and deploy their substantial cash reserves through stock buybacks, the stage is set for a significant uptrend in their valuations.

A Historical Perspective on Technological Growth

Looking back at past technological advancements such as cellphones, the internet, and computers, which sustained double-digit percentage growth rates for over a decade, there is a precedent for prolonged growth cycles in disruptive technologies. Analysts at Trivariate Research emphasize the potential for a second wave of success in the technology adoption curve, highlighting the opportunity for savvy investors to position themselves strategically for the next phase of growth.

In conclusion, while the current market conditions may deter immediate investment in tech stocks, a more prudent approach could involve monitoring for favorable entry points during potential pullbacks. With a solid long-term growth trajectory supported by historical evidence and optimistic forecasts, tech stocks continue to represent a compelling opportunity for investors seeking exposure to the dynamic world of innovation and technology.