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Investing in monikers like the ‘Magnificent Seven’ for AI exposure will only end in tears

08 May 2024

Identifying the profitable beneficiaries of AI, as well as those that may stand to lose, will be the key to active management outcompeting passive strategies.

By Simon Steele and Harald Karlsson,

Fiera Atlas Global Companies

Is every stock that makes up the ‘Magnificent Seven’ equally magnificent, or are some more equally magnificent than others?

The latter looks increasingly true. For while our obsession with the Magnificent Seven creates the illusion of a big tech collective, our analysis of consensus earnings expectations reveals a growing performance disparity that puts into question whether ‘magnificent’ is – at least for some of the group – a bit of an overreach.

Before we debate it, let’s step back. Why are the Magnificent Seven so magnificent in the first place?

Excluding these stocks from the S&P 500 charts an answer. Consensus earnings expectations for 2025 in the ‘S&P 493’ have declined 2.4% in the past three months; at the same time, the Magnificent Seven have seen a 5.4% rise. With such significant earnings outperformance, it’s little wonder that the seven were responsible for around a third of global market returns last year.

However, not everyone in this pack is cycling at the same speed. Nvidia fronts the peloton with consensus earnings expectations indicating a 320% year-on-year surge to 2025, reflecting its dominance over the semiconductor industry.

Still within view is Amazon’s 49% rise in its 2025 earnings forecast. Microsoft and Alphabet fall short with their respective 8.1% and 8.3% upticks, while Apple (experiencing a 6.2% decline) and Tesla (plummeting 38.5%) are pedalling backwards.

Perhaps the ’Magnificent two-to-three’ isn’t quite as catchy. But the disproportionate influence of Nvidia’s earnings performance and the recent decoupling of Apple and Tesla from the pace-setters does challenge the idea of the Magnificent Seven as a collective force.

And crucially – not least for those that see the Magnificent Seven as a proxy for exposure to the artificial intelligence (AI) theme – this divergence raises the red alarm that investing in the moniker (without respect for their differentiated business models, end markets and varying degrees of interfacing with AI) is misleading and potentially dangerous. 

Generalisation and its intrinsic biases is our pivotal concern. It is humanity’s condition to draw parallels in an effort to simplify complex and highly dispersed outcomes. There is a proverbial graveyard of private capital lost in long-forgotten themes and endless obituaries of companies that bandwagon on ‘hype’ but that have not delivered sustainable, profitable growth.

You don’t need to look further than the dot-com bubble to find examples of this kind of adrenaline-fuelled reductivism – and the poor stock selection it produces. 

Investors looking to exploit important trends such as AI must therefore be discerning in their stockpicking strategies. Rather than lulled into the false sense of security granted by collective exposure, it is for portfolio managers to look past the moniker and target companies benefitting from AI where new sources of demand generate long-term, high-margin growth opportunities that are indicative of a profitable and enduring market shift.

Similarly, investment portfolios should not bet the house on just one market trend or source of demand – investors must diversify risk and seek out multiple sources of structural demand growth. This means seeking out exposure to different end markets, different customer types and sources of demand that are uncorrelated to one another, to reduce portfolio risk.

For example, we observe a growing need for more robust cybersecurity in the face of growing malicious activity from state-sponsored and criminal actors. Enterprises must safeguard consumer data and protect against ransomware attacks, while also managing increased remote working and the effective ‘fractionalisation’ of their networks. Governments need to secure systems to prevent matters of national security ending up in in the wrong hands.

Fortinet is well placed to benefit, selling cybersecurity solutions that offer incredible value and strong performance to businesses and governments.

We typically avoid the pharmaceutical sector due to the unpredictable nature of drug discovery and expiring patents. However, tapping into the structurally growing research and development spend in global pharmaceuticals is possible through software that manages increasing data volumes in clinical trials and streamlines mission-critical aspects such as regulatory reporting, quality and safety. Many customers are upgrading from outdated, in-house legacy processes.

Veeva, a specialist in pharmaceutical software, is well positioned to capitalise on strong long-term growth and without the risks associated with betting on individual drugs. 

And in software development, engineers are utilising co-pilot programs that assist in writing, correcting and enhancing code, which could lead to significant efficiency gains and increased output, though it may also reduce the demand for computer programmers.

Be it chatbots replacing customer service agents in sectors such as banking, utilities, communications and online retail, or AI’s role in writing tasks and its effects on journalism, marketing, advertising and law, there exists a potentially infinite cosmos of applications for AI.

We can’t yet determine with certainty where its role as a productivity tool begins and its potential replacement for labour ends. But we can already see glimmers where AI can unlock capacity for higher-value activities – particularly in replacing repetitive manual tasks.

To that end, AI is undoubtedly reshaping various industries by boosting efficiency and productivity. Not unlike what we’ve witnessed throughout history, technological advancements are again changing the face of productivity. While impact will vary across sectors, opportunities to tap into this shift extend well beyond the veneer of the Magnificent Seven.

Identifying the long-term, profitable beneficiaries of AI, as well as those that may stand to lose, will be the key to active management once again outcompeting passive strategies. While there will be many winners in the broad adoption of AI, investors should maintain a balanced approach, emphasising diversification. Rigorous research and stock selection remain essential components of leveraging emerging trends for sustainable long-term gains.

Simon Steele is head of the Fiera Atlas Global Companies team and Harald Karlsson is an investment analyst. The views expressed above should not be taken as investment advice.

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