Mag 7 Stocks Going Parabolic Raises Caution Flag

The counsel from financial advisors advocating a portfolio heavily concentrated in the stock market, particularly growth stocks, as a cornerstone for young investors has continued amidst a backdrop of extraordinary returns propped up by governmental and Federal Reserve interventions over the last 15 years. Some advisors have gone so far as to endorse an overly aggressive equity exposure even into one’s retirement years. In an age dominated by modern monetary theory and rapid artificial money creation at the faintest hint of economic turbulence, embracing a risk-on approach sans trepidation of economic downturns appears logical. Following the substantial monetary and fiscal stimuli triggered in response to the onset of the pandemic four years ago, the stock market has surged on the tide of easy money and a seemingly sustained uptick in consumer outlays.

After enormous monetary and fiscal free money stimulus initiated when Covid began 4 years ago, the stock market roared higher on the back of a new elevated plateau of consumer spending. Despite the Federal Reserve presently extracting excess reserves from the banking system, the 20 month technology surge led by Nvidia, the harbinger of the Artificial Intelligence era, has masked any underlying market weakness. However, provided the trajectory stays on course for a soft economic landing, any market pullbacks may be intense yet ephemeral, considering the Magnificent 7 stocks persist in bolstering the AI domain. The remarkable 16% surge in the benchmark SP 500 Index during the initial half of 2024 distinctly outstrips the norm. Yet, it is essential to underscore to readers that the SP 500 and Nasdaq contain these Mag 7 companies and exhibit a pronounced skew towards the upside compared to most index constituents.

In this narrowly guided Bull market, only those heavily weighted in tech and mega-cap tech entities are keeping pace with the benchmarks. The aggregate valuation of the Magnificent 7 stocks has now reached approximately $16 trillion, yet their weighted returns fail to mirror the vulnerabilities in the indices they represent. The divergence has never been more starkly delineated than over the last six weeks, with the Mag 7 stock index soaring by 25% while the equal-weighted SP 500 index actually dipped by 3%. Roughly 75% of the SP 500 stocks are underperforming vis-a-vis the broader index, signaling a need for valuations to reconcile for the broader market to realign with the rapidly expanding mega-cap stocks.

Although our bullish outlook has persisted for months with minimal short-term correction forewarnings, we remain vigilant for traditional cues of an overdue correction that could unsettle investors. Options sentiment indicators, momentum and investor surveys are surprisingly neutral, substantiating institutional resilience through calm and consistent stock price closures above the daily mid-point over the preceding 8 months. Furthermore, the unusually robust seasonality during July, historically the most favorable month, augurs well for the Bulls. Many analysts are employing seasonality patterns, forecasting another victorious July for the Bulls. Such Bullish unanimity for a strong July may be too good to be true.

Our contrarian disposition prompts a cautious stance this month. Today we note the first hint of caution in this Bull market with the Purchasing Managers Services survey outcomes for June. It’s well known that the smaller manufacturing sector has revealed labor weakness for almost 2 years leading the majority of managers and economists to incorrectly forecast a recession.  However, it’s more relevant when surveys reveal a Service Sector with diminishing job openings and declining new orders. This rare occurrence often fortells of a prolonged economic downturn. A couple months in a row of negative PMI Service sector surveys are required for a recessionary or deeper slowdown confirmation. Although we maintain a long-term bullish outlook and anticipate swift money printing by the Fed in the event of deteriorating conditions, we advise against augmenting equities, particularly in the tech sphere, in the portfolio this month unless a general market correction exceeding 5% materializes.

 

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