Pundits seem to find it shocking that a small number of stocks like the Magnificent Seven should make up such a large portion of a major index like the S&P 500. I’m of two minds about this:

–on the one hand, most other major stock markets show this heavy-half structure most of the time. There are typically a subset of multi-nationals or of state-controlled enterprises, each of whom has a, say, 5%+ weight in the index and which in the aggregate dominate the index;

–on the other–and something no one seems to be mentioning in public comment– is that in the history of the US market, the kind of large-stock concentration we are now seeing has most often come at the tail end of an intensely speculative period. The conglomerate era of the late 1960s; the Nifty Fifty, “one-decision” stocks of the early 1970s: the peak of the oil boom in 1980 and, of course, the peak of the zero-interest-rate pandemic frenzy in 2021 are all prominent examples.

My guess is that we’re too close in time to the 2021-22 stock market collapse that happened as we came out of the the pandemic for another overall stock market collapse to occur. We will likely also have an equity-supportive fixed income market that will work against significant overall market PE decline. My guess is that the US stock indices will be down slightly next year, with gains in the rest of the market offsetting a, say, 10% decline among the members of the Magnificent Seven. 

I’ve owned shares of MSFT and NVDA for years, and have no present intention to sell. I’d probably trim on a significant rise in either, simply on position size grounds, but all other things being equal am content to hold. If I had to guess, I’d say both will go sideways for a while, though, and will only be driven higher by surprisingly strong reported earnings. If so, I’d guess the other five could be down by 10%-15% or so, which would translate into a 3%-5%-ish decline in the S&P 500. I’m figuring that most/all of that loss would be offset in the S&P 500 by potential strength of not-so-glamorous stocks in the rest of the market that show modest earnings growth. 

The contrary thesis would be that selling in the Magnificent Seven becomes so severe that investors start to perceive them as relative bargains and sell holdings in the rest of the market to switch into them. This is the way a bear market typically sustains itself, and we’ve got to be alert to the possibility. But, as I’ve written above, my main scenario is that a bunch of ok stocks offset the damage from the Magnificent Seven, not that very sharp declines in the Seven undermine the rest of the market.

The Magnificent Seven, the title of the 1960 remake of the Kurosawa film The Seven Samurai, has been repurposed by the financial press to describe the performance of the largest market cap stocks in the S&P 500 this year. 

The stocks in question, with approximate index weightings, are: Apple (7%), Microsoft (7%), Alphabet (3.9%), Amazon (3.5%), Nvidia (3%), Meta (2%), Tesla (1.7%). Together they make up just north of a quarter of the S&P 500 market cap …but also the lion’s share of the index performance in 2023.

S&P has up-to-date figures for the top 10, which is close enough (for me, anyway) to illustrate the “magnificent” point, which is:  the index as a whole is up by about 25% ytd through yesterday. The top ten, which make up a third of the index, are up by 64%. Putting this last figure a different way, the top ten account for 21 of those 25 points. This means the other 490 stocks in the index account for 4, that is, they’re up as a group by about 6%. 

What are the chances of a repeat in 2024 of the 2023 script? 

Well, NVDA has tripled based on its central importance for AI, and META and TSLA, both bouncing back from ugly 2022 performances, have more than doubled. Just off the top of my head, it seems to me that chances of a similar performance in 2024 are pretty low. Three reasons: trees don’t grow to the sky, as they say; we can already see the market broadening out and increasingly using valuation as a way of sorting wheat from chaff–so the Seven aren’t the only game in town; and, as just mentioned, neither the performance of META nor TSLA remain so “magnificent” if we consider the deep 2022 hole they were working their way out of.

more on this tomorrow

It’s Boxing Day in the UK, so no trading, not that that market has much contemporary relevance. Other smaller markets are getting ready to shut down at mid-week for a long New Year’s break. And the power players on Wall Street have long since closed their books for 2023, as well. 

Nevertheless, I find this ostensibly sleepy period one of the most entertaining weeks of the year. Volumes tend to be low, so even small trades tend to move markets by a relatively large amount. Then there’s the issue of the motivation behind anyone eager/desperate enough to be trading now.

One stock that is catching my eye is INTC, a stock who’s recent claim to fame is that’s gone 0 for the 21st century so far. It has yet to revisit the highs of the Y2K internet craze, while a name like MSFT is 8x that level (despite having been saddled with Steve Ballmer for all those years) and AAPL is 200x+. 

The company’s story, as I understand it, is that it has been the king of the microprocessor market from forever. Yes, its chips have been large, by today’s standards and run very hot, so they’re not the best for cellphones. Still, until perhaps ten years ago, the company led the world in process technology, so its chips’ greater speed offset the clunky.

Then engineers at TSMC, the world’s premiere foundry (meaning it manufactures chips that others design), caught up with–and then surpassed–INTC in small size/high speed. So users like GOOG, AAPL or MSFT could create bespoke chips that are just as fast as INTC’s, yet run cooler and take up less space. To me, INTC has seemed like a textbook case of company aging: the original innovators retire; bureaucrats replace them, focusing on cost-cutting instead of innovation; and the company becomes a shell of its former self. 

Recently, though, not only has INTC shifted gears to become a foundry itself, but the stock has visibly perked up–and INTC has begun to suggest that it has pulled even in process technology with TSMC for the first time in years. It will be interesting to see how the stock trades during the current quiet week.

Virtually all professional investors focus on performance vs. a benchmark index, i.e., relative performance. One reason is that this is what clients (likely also including ourselves) expect, even though they seldom see the managers they hire achieve this goal. A second is that it’s much easier to say A is a better buy than B than to say A is flat-out good. A third is that stock markets tend to react sharply to unexpected news rather than move little by little each trading session. So, historically anyway, the worst position to be in is to have a large cash position.

Maybe the most important consequence of this approach is the shift in conceptual framework this entails. We begin to perceive and quantify risk in terms of deviations from the structure of one’s benchmark index, in the expectation that we will get a better-than-index return by doing this. 

Let’s define a bad stock as one that you have either more than the index weighting in the (incorrect, as it turns out) expectation it will outperform or hold less than the index in the (again, mistaken) expectation it will be a dog. In my experience, making a mistake of the second type subtracts much more, say, 3x, than a stock that outperforms in the way your analysis predicts will add to performance. This means that identifying and eliminating mistakes is a much more important task for a portfolio than is generally realized. 

For any active managers, it’s way more important to know a lot–preferably much more than the consensus–about a few stocks where you have a high degree of certainty (in the best case, that most don’t realize yet) than to know an average amount about a lot of different companies. The latter approach ends up relegating you to likely being the dumb money everywhere. 

Experience will eventually tell you how much is enough to know. So to be successful you have to hold two potentially conflicting beliefs: you have the arrogance to be convinced you know more than the consensus does about each of your positions–or at least all the big ones; at the same time, you have to be humble/self-aware enough to understand that even the best pms are easily wrong 40% or so of the time. Everyone knows that you ride your winners and cut your losers. The real trick is to have failsafe measures in place to force you to do the second.

Happy Holidays!!

As far as professional equity investors are concerned, 2023 has already been in the books for weeks. 

There’s little to be done now that will affect this year’s relative performance, and there’s always big risk in any maneuver that has to play out within two weeks. So this is the one time during the year when it’s ok to go home and relax.

My expectation is that 2024 will be an interesting (which means “testing”) year. The traditional pattern is that the sitting president puts a little extra fiscal/monetary oomph into the economy during an election year on the idea that “it’s the economy, stupid” is the safest route to remaining in the Oval Office. The received wisdom is that the only president not to do this was Gerald Ford–and look what happened to him. Maybe add Jimmy Carter to that list.

Given that we’re in the aftermath of the pandemic, however, and trying to normalize ourselves after massive government stimulus, and saddled with a dysfunctional Congress, I think there’s virtually no chance of the typical election year boost to the economy. The other side of the coin is that there won’t be the following year letdown.

I think there’ll be lots of election-year noise. Biden won’t magically get younger. Trump appears increasingly unhinged (and I just don’t get how anyone can give him a free pass for having tried to stage a coup). My guess is that we haven’t scratched the surface of what has happened to the top secret documents Trump covertly left the White House with.  Recent reproductive rights litigation in Texas strikes me as showing that state’s government to be almost incomprehensibly cruel. Anyway, political developments may create lots of tradable ups and downs in the stock market based on the upcoming during the year.

As a citizen, I’m concerned. As an investor who also has a life, however, I’m not interested in short-term market moves, especially ones driven by political issues. 

my guesses

–overall, I think 2024 will be a sideways year, however volatile day to day trading may be

–let’s define concept as the elevator speech about the sources of future profit growth that make a company’s stock a good investment and valuation the price that comes from careful reading/analysis of a firm’s financials. 2020 was a purely about concept–and zero interest rates.  2021-22 was the air coming out of the balloon. During the first half of 2023, concept stocks bounced sharply, before giving up all their ytd gains during the third quarter. Recently, concept is back in fashion. 

–I’m finding that for now at least I’m building my portfolio by what I think of as a backwards methodology–more by what I want to avoid than what I’m desperate to hold.

—-I’ve held MSFT and NVDA for almost a decade, but I have little interest in the rest of the top 25 stocks in the S&P

—-I’m not interested in Energy or Materials (although there’s potentially something important in the Nippon Steel bid for US Steel, I think) or, to some degree, Industrials. These are all sectors that tend to do well when economic growth is strong, or at the beginning of a new business cycle

–I’ve started looking at smaller consumer-oriented names and stocks with high dividends

–I’m (unusual for me) finding myself more interested in good valuation than interesting concept, because I think the latter has still been picked over too much.