Why Apple, Magnificent 7 Stocks Aren’t the Big Risk Everyone Says They Are

The seven stocks account for more than a quarter of the S&P 500, which is weighted by market capitalization, so their rallies pulled the entire index higher. Most other stocks didn’t join the party until the November rally.

In fact, some strategists breathed a sigh of relief at the wide range of companies that joined the late-year surge. The concern had been that relying on such a small cohort of megacap winners put the market’s gains in danger. If that group headed lower, the reasoning went, so would the stock market.

Yet Benson Durham,
Piper Sandler’s
head of global policy and asset allocation, argues that that concern is misplaced. His research found that the Magnificent Seven generally don’t move in tandem, and that volatility in returns on the S&P 500 is a bit lower including the big tech firms than it would be without them. The same is likely to be true in 2024, he said in a Tuesday research note that makes the case that investors don’t face bigger swings in the index regardless of the seven companies’ outsize role in it.

To be specific, Durham wrote that based on a statistical model known as GARCH, for generalized autoregressive conditional heteroskedasticity, volatility in returns for the S&P 500 stands at 10.9% excluding the Magnificent Seven. Including the tech titans yields a result of 10.5%. The same model suggests a difference of 0.4 percentage points in 2024, he found.

In other words, the Magnificent Seven’s extraordinary influence hasn’t supersize risk.

That might not seem logical, but as Durham notes, the math bears it out. Each of the seven might have higher volatility than the index as a whole, but the correlations among the stocks are relatively modest. They don’t move in lockstep in a way that would make the index so statistically concentrated as to increase risk.

In fact, he said, the “M7 stocks afford as much diversification as investing across sectors.”

Again using a GARCH model, he found that the average dynamic correlation among the daily returns of pairs of Magnificent Seven stocks has been, and remains, lower than among sectors in the S&P 500. The correlation among the big tech stocks is about 0.41, compared with 0.496 for the sectors.

The higher the correlation, the greater the likelihood that the assets move in the same direction. It all means that the 11 individual S&P 500 sectors tend to trade in tandem slightly more often than the Magnificent Seven.

In addition, Durham’s analysis shows that about 51.2% of the M7’s variance—defined as their volatility squared—comes from one top factor, “while the biggest common dynamic factor ‘accounts’ for about 52.3% of the variation across S&P 500 sector returns,” he wrote. “As such, investing in M7 stocks has no more ‘common exposure’ than investing across the range of S&P 500 sectors does.”

The takeaway is that counterintuitive as it seems, the M7 stocks aren’t much riskier, in the sense of being volatile, than the S&P 500’s broader industry sectors, even though these contain more companies.

That might have provided cold comfort to investors on Tuesday morning, when each of the Magnificent Seven stocks began the new year by trading lower. Apple, which received a downgrade to start 2024, led the way.

Yet by early afternoon, Tesla was flirting with small gains. Only Apple, was still bogged down with a 3% decline.

While Durham believes that investors shouldn’t avoid the Magnificent Seven this year in an attempt to lower risk, others have argued there are other reasons to stay invested as well. Technical analysts and strategists have been bullish on big tech, while plenty of fundamentally focused research points to more gains for companies innovating in artificial-intelligence technology. That includes smaller tech names as well as the M7.

In sum, just as 2023 brought a rally no one expected, 2024 will likely have plenty of surprises. Yet there is less reason to be concerned about the role of the Magnificent Seven. The tech party may not be over.

Write to Teresa Rivas at [email protected]