As global investors closely monitor the potential bubble in artificial intelligence (AI) and the remarkable performance of the Magnificent Seven stocks, it is crucial to examine historical market trends. The Bank of America, under the leadership of Michael Hartnett, has conducted a thorough analysis of past bubbles and drawn valuable comparisons to the present situation. According to their findings, it is likely that higher real interest rates will ultimately lead to the downfall of this group of stocks.
Following an exceptional surge in the stock prices of seven prominent tech companies last year — namely Tesla Inc., Microsoft Corp., Apple Inc., Amazon.com Inc., Alphabet Inc., Nvidia Corp., and Meta Platforms Inc. — several of these entities continue to experience substantial gains alongside other technology firms.
To better comprehend the current landscape, Bank of America provides a chart that juxtaposes historical bubbles such as the South Sea and Mississippi bubbles of the 1700s, the roaring 20s for the Dow industrials, and the dot-com bubble of the 1990s with the ongoing Magnificent Seven run.
While each bubble is unique in its own right, Hartnett and his team identify catalysts, pricing trends, valuations, and the “price of money” as essential factors for evaluating the Magnificent Seven today.
Regarding catalysts, the strategists emphasize that past bubbles were driven by technological innovation, new sources of geographical growth, and crucially, central bank easing — a scenario not dissimilar to the present circumstances.
By examining history and drawing parallels between prior market bubbles and the current AI phenomenon, investors can gain valuable insights into the possible trajectory of the Magnificent Seven stocks. However, it is vital to remain watchful of the impact that higher real interest rates may have on this dynamic group of companies.
The Magnificent Seven and the Boundaries of Price
The recent surge in price among the Magnificent Seven companies has been nothing short of astonishing. With a 140% gain over the past 12 months, these companies are inching closer to the impressive rises seen in the Dow industrials DJIA during the 1920s and the Nifty 50 blue-chip stocks that drove the bull market of the early 1970s. However, it should be noted that the Magnificent Seven still have a long way to go before they reach the remarkable 230% surge experienced by the FAANG stocks following the lows of the COVID-19 pandemic.
While the Magnificent Seven’s rise has been impressive, their valuation of 45 times earnings remains relatively low compared to other bubble runs.
But what truly matters for the future of the Magnificent Seven is what they call the “price of money.” Historical data shows that in 12 out of 14 observed bubbles, bond yields were rising as the bubbles reached their peak or burst, and financial conditions were tightening. Examples include the internet bubble bursting due to 4% real rates, China’s stock bubble being popped by 2% rates, and the subprime bubble being deflated by 3% rates.
Considering the significantly higher levels of global debt in comparison to history and 10-year real rates at 2%, market experts predict that rates between 2.5% and 3% will likely bring an end to the AI and Magnificent Seven era.
Despite these concerns, investors remain relatively unfazed, viewing technology stocks and corporate bonds as the new “all-weather” asset classes. The tech sector funds have already seen staggering year-to-date annualized inflows of $85 billion this year, with $500 billion flowing into investment-grade bonds.
It seems that for now, the Magnificent Seven continue their ascent, but only time will tell if they can sustain their glorious run in the face of changing market dynamics.
