WHAT do the years 1960, 2016 and 2023 have in common? Answer: The Magnificent Seven.
In 1960 and 2016, respectively, the original cowboy movie and its remake hit the box office. Last year, however, the blockbuster surge had a vastly different nature.
In 2023, seven mega-cap tech stocks (Amazon, Alphabet, Apple, Meta Platforms, Microsoft, Nvidia and Tesla) elevated the S&P 500 with a return of 26.3 per cent, compared to 13.8 per cent for the equally weighted S&P 500.
This strong showing begs the questions: Have these mega-cap tech stocks had their high noon? Should we look to other sectors to drive investment performance in 2024?
Although the seven stocks made a 44 per cent leap in earnings per share (EPS) in 2023, we feel that a repeat of the share price performance this year is unlikely. The Internet sector’s outperformance in 2023 was in large part due to a multiples expansion.
While we won’t see those easier gains this year, we do think fundamentals are better positioned than last year, with broad sector multiples still below their historical averages. Crucially, the EPS of the other 493 stocks in the S&P 500 came in at minus 4 per cent in 2023.
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Citi Research expects an ongoing focus on margins, but also a return to a growth orientation as investors search for broader returns than just among the Magnificent Seven.
Broad sector momentum
As we move through the first few months of 2024, it is our view that the momentum in the second half of 2023 across the broader Internet sector, and particularly the subsectors of online advertising, e-commerce, marketplaces and online travel sub-sectors, can continue.
We like companies that are investing in product, gaining share in their respective markets, and delivering margin expansion.
Most have gone through cost reduction and optimisation themselves, triggered in large part by the forced economies of the pandemic. Now their margins are expanding sustainably, and their balance sheets are improving.
Central to this theme has been the emergence of generative artificial intelligence (GenAI) brought to the forefront of markets in November 2022 with the public launch of ChatGPT by the not-for-profit company OpenAI. The technology has been years in incubation among the mega-cap tech companies, but entered the zeitgeist with the launch of ChatGPT.
There appears to be no area of the economy that will be untouched by GenAI; productivity is likely to be enhanced across a multitude of industries with it. What will differentiate the winners from the losers will be how quickly it is adapted and adopted.
Look to adopters of new tech
The market has been quick to re-rate the mega-cap tech stocks, which have been the initial enablers of this new technology.
Slower to respond by way of valuation have been those potential adopters of this new technology. Such stocks have the potential to secularise this trend well beyond the initial impact it has had on the technology sector. This was what Microsoft chief executive Satya Nadella meant when he described GenAI as having the potential for being the next Industrial Revolution.
Key Internet trends for 2024 include online advertising, which we project will grow 12.4 per cent year on year in the US, led by GenAI, short-form video and e-commerce, which we expect will grow 9 per cent and account for 22 per cent of overall US retail sales in 2024.
We also expect to see a shift this year from a reliance on screens to voice as the large-language models become conversational – and crucially – more naturally conversational. We anticipate that through the use of agents/bots and the adoption of personalities, GenAI can deliver greater engagement trends, conversion rates and transform customer-service tools.
Specifically, the online travel industry looks ripe for transformation through the incorporation and use of AI recommendations through virtual agents.
A further advantage for those firms looking to capitalise on the potential adoption of GenAI, is access to a large consumer or corporate client base, which in turn favours many of the Magnificent Seven stocks.
Spotlight on semiconductors and cybersecurity
Global semiconductor names are key to empowering the roll-out of AI infrastructure as adoption accelerates.
As market focus shifts back to AI and data centres, we identify two potential areas of related AI spending that are poised to benefit. These are customised AI chips to run the AI functionality of data centres, and AI network infrastructure – graphics processing unit designers who help to power hyperscalers.
Application-Specific Integrated Circuits (ASICs) are chips with both cost and power efficiency, tailored for specific AI systems. Within the semiconductor producers, ASIC chip production has meaningfully differentiated performance across the sector over the last year.
However, we do see 2024 as the year in which the broad semiconductor sector starts to catch up as ASIC investment accelerates.
While 2023 was a trough year for the broader semiconductor sector, 2024 will be a resurgent year led by memory. The memory chip space is witnessing an inflection, and we expect total Dynamic Random Access Memory (DRAM) sales to increase roughly 80 per cent year on year from US$47.3 billion in 2023 to US$84.6 billion in 2024.
We see many opportunities beyond the mega-cap tech names, specifically relating to AI spending and different aspects of the semiconductor sector.
With geopolitical tension ramping up in 2024, so too has the threat of cyberattacks, fuelled by the growing misuse of AI technology for more nefarious means.
Cybersecurity and the necessary investment for it are front of mind among chief financial officers and defence secretaries alike. Earnings broadly kept up with price in 2023. We see value in the quality names in this sector, as IT departments of both corporate and state entities have to ensure round-the-clock protection in this digital battleground.
Considerations
As with all investments, there are risks. Valuation multiples and expectations of the Magnificent Seven tech stocks are high, such that the S&P 500 is trading at a price-earnings (PE) multiple of 19.9 times (2025 expected earnings).
The multiple for the equally weighted S&P 500 drops to an affordable 15.9 times. For the small- and mid-cap sector, the PE is comfortably below 15 times.
While price is a factor, earnings growth is key. Multiples can stay the same, but earnings growth ahead of expectations can drive and has driven meaningful share price performance over the last year. Again, the bar is very high among the GenAI enablers, and lower among the potential adopters.
Another issue to watch is antitrust headwinds, which are expected to grow stronger with high-profile cases by regulators against mega-cap tech companies’ practices, accompanied by punitive measures.
Will the Magnificent Seven still command the investor box office in 2024? Film sequels rarely gross more than their original. That’s likely why studios such as Marvel choose to broaden, explore and monetise the extended universe.
The writer is an investment counselor team lead, Citi Private Bank
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