I have a friend who’s owned a number of successful cafes in his time.
I once asked him the secret to his success.
I mean, Melbourne’s not short in supply when it comes to cafes!
He replied:
‘Yes, there’s a lot of cafes. But the thing about Melbourne is that everyone wants to have breakfast at the same few places. You need to make sure you’re on that list to make it.’
That answer has always stuck with me.
And whenever I’m out and about, I can always see how true it is. One café buzzing, the one next door dead.
In analyst jargon, the distribution of customers isn’t even. It’s skewed heavily to the few success stories, while most others struggle to stay afloat.
As an investor, the same is true. The path to investing success is often a narrow one.
If you miss out on the few high flyers, then you miss out on the bulk of the gains on offer.
For example, check out this amazing chart…
A growing chasm
This chart shows the returns in various sectors of the US stock market since the start of the year:
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| Source: Ten31 |
Including dividends of 0.85%, the S&P 500 (the most valuable 500 stocks in the USA) is up 17.57% so far this year.
That’s pretty good, given we’ve still six months to go.
Incidentally, our own ASX 100 of leading Aussie shares is up a more meagre 8.4% for 2024, with dividends making up a whopping 4.47% of this total.
But the deeper story about the US market is where the bulk of these returns are coming from.
Check out that growing chasm between the green and blue lines.
As you can see, the so-called ‘Magnificent 7’ tech giants — Alphabet (Google), Amazon, Apple, Meta, Microsoft, Nvidia and Tesla — are responsible for the bulk of the S&P 500’s gains.
Indeed, if you strip those 7 out, the other 493 stocks are only up a more modest 7.5% this year.
What’s worse, investors in the Russell 2000 small-cap index are yet to see any gains this year!
It appears investors are choosing their stocks like Melburnians choose their cafes.
They all want in the same ones at the same time!
What to make of all this…?
The race is on
Undoubtedly, the ‘Mag 7’ have been the primary beneficiaries of the year’s big tech story.
Namely, AI (artificial intelligence).
The narrative makes superficial sense.
These seven companies have the products, the distribution, and the capital to create a future AI-led world.
And investors are clamouring over themselves to get on board.
But here’s the thing…
We know from the late ‘90s dot com boom that technological leaps are hard to navigate.
The path to adoption is messy and unpredictable. And you’re always dealing with second and third-order effects, as well as fierce competition for new customers.
In such a turbulent mix, investing mistakes are easy to make, especially if they sound reasonable.
For example, at the start of the internet era, everyone thought networking stocks like Broadcom were the stocks to own.
They were the new ‘railways’ of the digital world.
A great story, for sure.
But as it turned out, they weren’t the stocks to own.
Instead, consumer-facing plays like Google, Amazon, Netflix, and Facebook ended up being the big winners from the advent of the internet.
They better created the ‘moats’, to capture the value on offer, not the network plays.
So always remember this…
Which brings us to the pressing question…
Is the hype in these Mag 7 stocks now overdone?
I mean, if AI is meant to drive wider economic efficiencies, why isn’t the general market catching a better bid?
And if AI will drive entrepreneurial growth like the internet did, why are small caps still languishing?
These are questions worth pondering right now.
Indeed, a new report from Goldman Sachs late last week poured some cold water on the AI hype.
An MIT professor featured in the report noted :
‘Given the focus and architecture of generative AI technology today… truly transformative changes won’t happen quickly and few—if any—will likely occur within the next 10 years.’
The ‘Mag 7’ are set to spend over US$1 trillion in AI capital expenditure over the next few years on infrastructure like data centres.
So, if the professor’s timeline turns out to be true, we’ll see a painful fall at some stage as investor expectations are pared back.
Maybe even a dot-com-type bust.
Though, I’d also note that other authors in the same report were more optimistic.
They predicted the timeline of AI success would be defined by how long it took to create the first ‘killer AI application’.
As reported:
‘While it is unclear exactly what the killer application for AI will be, current progress has led some analysts to believe that the current growth line can continue.’
In other words, it’s a race between three things:
Adoption, infrastructure spending, and investor confidence.
How that trifecta of fast-moving targets works out is anyone’s guess.
And let me be clear, I’m still confident in AI’s potential to disrupt entire industries.
But as an investor, I’m widening my gaze beyond the Mag 7.
I like an overcrowded trade as much as an overcrowded café!
And if the internet was anything to go by, the few firms that can produce the ‘killer apps,’ will be the ones you want to own as early as possible.
Keep your eye out for them…
Regards,
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Ryan Dinse,
Editor, Crypto Capital and Alpha Tech Trader
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