All animals are equal, but some animals are more equal than others. As fans of George Orwell know, that aphorism applies to more than just egalitarian livestock. Likewise, it may be said that some of the Magnificent Seven stocks are more magnificent than others.
That’s the takeaway from Benson Durham’s latest analysis of last year’s big tech winners, namely Apple, Amazon, Alphabet, Meta Platforms, Microsoft, Nvidia, and Tesla.
Last week
Piper Sandler’s
head of global policy and asset allocation argued that investors avoiding the M7 in an attempt to reduce their risk are misguided, as the group is plenty diversified despite its seeming homogeneity.
That, in his opinion, is what makes the group truly ‘magnificent;’ after all, it is extraordinary that such a small handful of megacap companies, broadly related to tech, could have such little concentrated risk.
On Tuesday, Durham took another crack at these stocks, to see if they are similarly superlative in terms of rewarding shareholders beyond systematic risk. And here, some passed the test with better scores than others.
It all comes down exposure. After all, equities are inherently risky, but investors are incentivized to put their money in the market nonetheless because they expect to be rewarded for taking on that greater risk. The greater the risk, the greater the (potential) reward.
In part, that’s why the S&P 500’s biggest winners in recent years tend to be volatile; investors are placing big bets, but those can turn out handsomely if the gamble breaks in their favor.
Therefore, Durham posits that if the M7 stocks mostly just compensated investors for the common risks they took on by buying shares at the beginning of 2023, that would make their returns less magnificent and more ordinary; i.e. they would simply be working as investors expect stocks to work.
To determine if that’s the case he traces how much of each of the M7’s returns can be traced back to systematic exposures. Put another way, how much is the excess alpha return investors seek compared with broader market’s overall risk, or beta.
To do so Durham analyzes not only the beta but also ranks the stocks vis-à-vis the
S&P 500
in terms of value, momentum, quality, and low risk as well, for the 255 trading period ended Jan. 8. Combining those scores shows how much of each stock’s rise is risk compensation, and how much is residual returns beyond that.
These numbers show that Meta and
Nvidia
are standouts. As Durham writes “most of the cumulative (total logarithmic) returns to Meta don’t owe to the systematic exposures. i.e. of the 198% return, only 48% is ‘factor-based’…The remaining 150% is a very welcome, if not ‘magnificent’ residual, over three times the systematic return from the start of 2023 through yesterday.”
As for Nvidia, its 258% total returns are about equally split between cumulative dynamic risk, 126%, exposure and the residual, 132%—not as striking as Meta, but also not too shabby.
Alphabet,
Amazon
and Tesla follow a similar pattern albeit with lower total returns. Meanwhile Durham’s analysis shows that
Apple
and
Microsoft
appear to be “less magnificent,” with the majority of their returns owed to risk exposures. “Therefore, the gains on these stocks mostly comprise compensation for common factor risks rather than idiosyncratic returns, which account for no more than a fifth of returns in either case,” he writes.
All of that is to say that statistically, Meta and Nvidia’s returns do seem to standout, while the others may be more closely mirroring risks, making their rise more ordinary.
Nonetheless, Durham stresses that despite the varying levels of magnificence in the M7—and the fact that these methods can at times “push the limits of some econometric techniques”—it doesn’t contradict his previous finding that the M7 are diversified and don’t raise the risk profile of the overall market.
“Also, naturally none of these analyses connote that any ‘abnormal’ benevolent returns will continue—we’ve just parsed realized returns—and we have zero views on fundamental valuations,” he writes.
Of course many others are more than happy to make the fundamental argument. Analysts see chip stocks like Nvidia rallying higher, while artificial intelligence remains a driver for companies big and small and the M7 momentum continues.
Those arguments have been put to the test in the new year, as tech underperformed in the first trading days of 2024. Nonetheless, the sector had a good day to start the week, and bulls remain confident it can keep climbing.
Time will of course tell. But it’s worth remembering that being an outlier works both ways; ‘benevolence’ is only one side of the coin.
Write to Teresa Rivas at [email protected]
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