Are the 'Magnificent Seven' Stocks Now Unstoppable?

Written by Simon White, Bloomberg Macro Strategist

The largest companies in the United States are increasingly outpacing their smaller competitors by earning more, investing more, maintaining larger cash reserves, and buying back more of their own stock. This trend suggests that the bull market may continue to be historically subdued and less robust as smaller companies struggle to keep up with their larger counterparts.

The Rich Get Richer

The phrase "the rich get richer" is particularly applicable to the most valuable companies in the United States. The term "Magnificent Seven" has become a common reference to a group of some of the world's largest companies, including Nvidia, Apple, and Amazon. However, the growing dominance of these large firms extends beyond the monopolies or oligopolies that many of them benefit from. They are also strengthening their financial positions and investing in the future in such a way that they are leaving their smaller competitors behind, solidifying their lead.

Market Concentration

Large-cap indexes in the United States have never been so concentrated, with the Magnificent Seven accounting for 27% of the S&P 500's market cap. This outperformance really began to surge during the pandemic. If we expand our view to the largest 50 stocks in the S&P, we can see that these began to significantly outperform the index's smallest 250 members after 2020.

Reasons for Dominance

There are at least five reasons for this dominance: 1. Massive loosening of monetary policy during the pandemic. 2. The US running its largest ever pro-cyclical deficit. 3. Tech firms benefiting from mass working-from-home during Covid. 4. Companies taking advantage of the pandemic disruptions to raise margins by almost more than they ever have before – with the largest firms taking advantage of monopolies to raise prices the most. 5. The AI boom kickstarted by ChatGPT. These advantages are allowing the largest firms to move into an unbeatable position, relegating the smallest ones to a permanent second-place status. This situation suggests that the bull market is destined to be milder compared to historical bull runs, and also less robust.

Earnings and Investment

Market concentration can also be seen in earnings, with the largest 50 firms accounting for 35% of the S&P's total Ebitda. An acceleration in earnings at the largest firms since the pandemic is reinforcing this effect. The top 50's Ebitda has risen over 3.5x since 2020, while it has only doubled for the smallest 250 companies in the S&P. These earnings are further ingraining big firms' advantage. They are now outspending their smaller counterparts on future investment on an unprecedented scale. Tech firms are pouring money into GPU chips, data centers, and energy production in a way that makes it increasingly impossible for others to ever catch up – not only in technology, but across the economy as AI continues to reduce the need for many jobs.

Cash Positions and Volatility

The largest firms are also bolstering their cash positions. While smaller companies' cash and marketable securities have only marginally increased since the pandemic, the cash reserves at large firms are growing stronger and are on a strong upward trend. The biggest 50 companies in the S&P hold 53% of the index's total corporate cash, compared to only 8% for the smallest 250. Having cash is essentially being long volatility. If anything unexpected happens, you are in a better position to deal with it. A financial shock causes margins to rise? That cash is there to cover it. A rival goes bust? The cash can be used to acquire it on the cheap. Smaller firms are increasingly short volatility and are vulnerable to or are unable to capitalize from unexpected shocks.

Interest Expenses and Debt

This cycle has been dominated by rising rates, so it’s no surprise interest expenses have increased across the board. The largest and the smallest firms have seen their quarterly interest costs climbing by about $7-8 billion since the pandemic. Yet once again, the largest firms come out on top. If we look at interest coverage, i.e., the ratio of Ebit to interest expense, the biggest companies' coverage has been pretty stable, while the ratio for the smallest has been falling. In level terms, the difference is even more stark, with the biggest companies' earnings covering their interest 25 times, versus only six times for their smaller counterparts. Even taking into account the extra interest received by corporates, the largest companies still come out on top. Furthermore, both small and large firms have taken on more debt in recent years, but bigger companies are less vulnerable to debt downgrades as their cash position has risen even more relatively.

Stock Buybacks

If all that is not enough to make the largest companies' shares more attractive, they are also diverting more of their accelerating earnings to buying back their stock, mechanically helping to boost their price through reducing the share count. Smaller companies have not had the resources to match them, even though in the years before the pandemic total buybacks were similar for small and large firms alike.

Implications for the Bull Market

Like a camel train in the desert, smaller firms are at the back and falling further behind. This has implications for the bull market. The current one is mild compared to previous episodes, consistently lagging the average bull market over the last 35 years. However, a closer look reveals why. The biggest stocks are now cleanly outperforming the average bull advance. However, the smallest S&P stocks are heavily lagging behind their average bull performance. Without any significant change, the bull market is likely to continue to pale next to the more virile examples in recent decades. That’s not to say the largest stocks are immune to a correction or periods of underperformance. It certainly doesn’t help that they are viewed as the most crowded and consensus trades among US fund managers (according to BofA’s Global Fund Manager Survey).

Conclusion

But it’s difficult to see — other than through their own unforced errors, or a complete reappraisal in attitudes to the near-term capabilities of AI and other new tech — how small companies can catch up on their larger rivals. Big is beautiful — and most probably now unassailable.

Final Thoughts

The dominance of the 'Magnificent Seven' and other large firms raises important questions about the future of the economy and the stock market. Will this trend continue, or will smaller companies find a way to catch up? What are the implications for investors and the broader economy? We invite you to share your thoughts and discuss this article with your friends. Don't forget to sign up for the Daily Briefing, which is delivered every day at 6pm.