Will tech’s Magnificent Seven ride again after shedding $2.3trn?

With high-growth expectations baked into their valuations, technology stocks have always been susceptible to big swings.
Turbocharged by indications of a strengthening American economy, the prospect of interest rate cuts and artificial intelligence hype, a select group of stocks — the so-called Magnificent Seven — now account for more than a third of the S&P 500 by value, and have generated the bulk of the blue-chip index’s gains.
The Mag-Seven — Alphabet, Apple, Amazon, Meta Platforms, Netflix, Nvidia and Tesla — that have powered most of this year’s stock market gains have had a rough few weeks, shedding more than $2.3 trillion since a July peak.
Weak economic data from the United States and a mixed set of earnings from the tech giants have prompted a sell-off as investors become more risk averse. A fall in the shares is a logical response to suggestions of a darker outlook, but the question is whether the magnitude of the sell-off is overblown.
Attempting to hold costs down in the face of the AI rush sweeping through the tech industry is seemingly futile. The Google parent has been intent on bringing expenses down, cutting headcount in four consecutive quarters.
Capital expenditure was $13 billion in the second quarter alone, ahead of expectations of $12.2 billion, $1 billion more than the previous quarter and almost double the amount it spent in the same period last year. Analysts expect the full-year figure to blow out to $49 billion this year, up from $32.3 billion last year, as it attempts to take ground from rival cloud computing platforms at Amazon and Microsoft, which have stolen a lead.
Analysts have feared that ChatGPT, the AI chatbot, could disrupt the search engine industry, where Google has been king since launching in the 1990s. That has not yet materialised, with search revenue rising another 14 per cent year on year in the second quarter. That helped boost the margin to 32 per cent, from 29 per cent a year earlier.
But Alphabet still derives more than three quarters of its revenue from advertising, which has taken a hit over the past year as corporate marketing budgets have retrenched. In the second quarter its core ad business slowed, posting an 11 per cent rise in sales year on year, compared with a rate of 13 per cent in the earlier three months. A more pronounced slowdown could make higher spending more uncomfortable.
Entering this year, Amazon was one of the best plays on the anticipated recovery in the health of the American economy. But disappointing second-quarter sales growth and an outlook for the present quarter that was also behind analyst expectations have reversed the rally in the shares and prompted its worst one-day fall since April 2022.
Net sales growth for the core North American ecommerce business slipped to 9 per cent in the second quarter, from 12 per cent the quarter before. Volumes have remained strong, but average sales prices have fallen back, which suggests that shoppers could be more cautious. Margins for that business also compressed for the second consecutive quarter, blamed on spending on some of its side bets.
The trajectory for spending could be key to winning investor confidence. Capital expenditure is set to be higher in the second half, according to Brian Olsavsky, Amazon’s finance chief. Much of that investment will be centred around Amazon Web Services, which has the largest share of the cloud computing market and is its main avenue for exploiting the adoption of AI among businesses. The division is seen as the jewel among Amazon’s sprawling ventures. Sales growth for the business accelerated during the second quarter, but margins slipped back to 35.5 per cent, from 37.6 per cent in the first three months of the year.
A forward price/earnings ratio of 31 is the lowest since 2010. But if the US economy is heading for a downturn, investors could become less tolerant of rising capex.
Warren Buffett made an exception when he began building a stake in Apple at the end of 2016. But the “Sage of Omaha” has sent an almighty bear signal to the market, halving his holding in the iPhone maker since the start of this year and shedding $50 billion in stock during the second quarter. That move looks well-timed.
Sales growth of 5 per cent was ahead of analyst forecasts during the second quarter, but what counts is how the iPhone fares. Sales for the smartphone edged down to $39.3 billion, from $39.7 billion.
The risk of a worsening economic situation in China continues to hang over the stock. Sales in the country disappointed expectations, down 7 per cent, despite increased promotional activity. Demand for the iPhone faces challenges not only from the economic downturn, but also rising competition from locally made handsets.
There is also a broader saturation risk given the iPhone’s market dominance. Apple is reliant on the release of new models to drive customers to upgrade their handset.
It has taken the Facebook and Instagram owner some time to convince investors that its splurging on its loosely defined bet on the “metaverse” will yield returns.
Second-quarter figures might have allayed some concerns. Revenue for the world’s largest social media company rose by 22 per cent to $39.1 billion in the three months to the end of June, ahead of analyst forecasts of $38.3 billion.
That might allow the company to continue spending on AI, which includes helping advertisers better target customers on its social media platforms. There are signs that it might be paying off. Ad impressions per post on its apps were 10 per cent higher and the average price paid per ad was also 10 per cent higher. The operating margin widened to 38 per cent in the June quarter, from 29 per cent a year earlier, as revenue growth outpaced cost growth by some way. Reality Labs, its virtual reality division, remains a sore spot. Losses are expected to increase “meaningfully” year over year. The chief risk for Meta is whether it can maintain its advertising gains in the face of a shaky outlook for the US economy.
Microsoft’s valuation has been inflated by moving early to capitalise on demand for generative AI via a $13 billion partnership with OpenAI, the start-up behind ChatGPT.
Despite the sell-off, Microsoft is burdened by high expectations. At 30 times forward earnings, the shares are not far off a record multiple of 35.
Sales growth of 29 per cent in the second quarter looks impressive. But it was weaker than the 30 per cent analysts had expected and behind the 31 per cent rise in sales in the previous three months. The pace is set to slow again to 28-29 per cent in the present quarter.
Microsoft blamed demand outpacing capacity, a trend that is expected to continue in the present quarter. Demand for Azure, its cloud computing platform, is driven in part by Microsoft’s generative AI products. Capital spending rose to $19 billion in its fourth quarter, with cloud and AI-related spending accounting for nearly all of the expenditures.
Not surprisingly, that trend is set to continue into the new financial year. Microsoft does not look stretched. Net cash generated by its operations rose to $37.2 billion, from $31.2 billion in the previous quarter. Funds on the balance sheet stood at $75.5 billion at the end of June.
There are indications that elevated spending is working. Azure sales growth has outpaced rival platforms at Google and Amazon, pushing its market share to 35 per cent at the end of last year, from 32 per cent a year earlier, according to analysis from Barclays.
No stock has encapsulated the buzz around AI like Nvidia, the chipmaker that has delivered a 114 per cent share price return since the start of this year, even after the recent sell-off.
The Santa Clara-based group has been boosted by the demand for its data centre chips and graphics processing units, which has continued to grow as businesses race to expand AI. It dominates the market for the powerful processors needed to power large language models, counting the likes of Microsoft, Meta Platforms and Amazon among its customers.
The question is whether a bubble is emerging. Impressive earnings growth has helped bring down the stock’s valuation. Elliott Management, the activist hedge fund, has told clients that Nvidia is in a “bubble” and that the technology driving the stock is “overhyped”.
Others disagree, with Blue Whale, the fund backed by billionaire Peter Hargreaves, buying the shares as the global sell-off ripped through markets.
Nvidia has started to grow into its valuation after recording rapid sales growth over the past 12 months. It has made a habit of beating lofty expectations, with revenue in its most recent quarter rising by 262 per cent. The shares trade at 31 times forward earnings, down from a multiple of 62 at its peak. A price/earnings growth multiple of 0.7 could make the meteoric rise in the share price easier to justify. A ratio below one is considered to indicate value. Still, its valuation leaves room for little error.
The challenges facing Tesla stretch beyond the health of the American economy. The electric carmaker has put through several price cuts across major markets like Germany, the US and the UK in an effort to stimulate demand. The result has been an increase in vehicle delivery volumes during the second quarter, but a 7 per cent fall in automotive revenues.
Tesla is also battling rising competition, which has exacerbated the price war, particularly with Chinese manufacturers.
But Tesla is still spending on AI projects at a pace, which meant that operating expenses rose by 38 per cent, sending profits down by 45 per cent during the second quarter to $1.5 billion. It has laid off more than 10 per cent of its employees in the face of slowing sales, which cost more than $350 million. Analysts have forecast a net profit of $7.8 billion this year, down from $10.9 billion last year. With the shares trading at 66 times forward earnings, another upset could still cause considerable damage to the company’s valuation.