The so-called "Magnificent 7" (Amazon, Apple, Meta, Alphabet, Tesla, Nvidia and Microsoft) almost single-handedly lifted the S&P 500 to its 24% gain in 2023.
But the market's saviors last year could be its downfall in the future, according to Jon Wolfenbargerfounder of the markets newsletter site BullAndBearProfits.com and former investment banker at Merrill Lynch and JPMorgan.
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In a Jan. 22 note, Wolfenbarger compared the current environment to the dot-com bubble of the late 1990s and early 2000s, during which Internet stocks drove the market to stellar returns before crashing spectacularly.
"For those of you younger than us who didn't live through the tech bubble of the late 1990s, you are now living through the tech bubble 2.0. As a reminder, the NASDAQ fell about 80% when that bubble burst in the mild recession of the early 2000s," Wolfenbarger said. "Given that stock market valuations are even higher now than at the peak of the 2000 tech bubble, we wouldn't be surprised by a similar decline in the next recession."
There is evidence to support Wolfenbarger's claims about the bubble, starting with fairly standard valuation measures like the Shiller Cyclically Adjusted P/E Ratio. While it is not as high as during the dot-com bubble, it is higher than in 1929 and is at one of the highest levels in history.
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Then there is concentration. The top five stocks today represent a much larger percentage of the S&P 500 than they did at the height of the dot-com bubble, making this a dangerously concentrated market at the best of times.
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Bank of America's Michael Hartnett has also called the AI โโboom a "birth bubble," as trading returns rise to 200% and continue to rise toward Internet bubble levels.
Bank of America
About half of the world's fund managers have also said the "Magnificent 7" is the most crowded trade globally, according to Bank of America's Global Fund Manager Survey.
"That means that despite its big advance last year (recovering from the huge drop in 2022), investors are still expecting many more upsides to come," Wolfenbarger said of the survey results.
Bank of America
As for what will ultimately deflate the bubble, Wolfenbarger expects a recession to hit the U.S. economy. He pointed to some labor market indicators, such as a declining number of full-time employees and downward revisions to job earnings, as evidence that the economic outlook will worsen.
The number of full-time employees fell sharply from November to December and has been on a downward trend since June 2023. If the trend continues, the decline could quickly begin to resemble what it saw in the 2001 and 2008 recessions. .
St. Louis Federal Reserve
Wolfenbarger also highlighted job creation revisions, which are negative on a year-over-year basis by more than 300,000 jobs, resembling patterns seen in previous recessions. Still, job creation has remained positive despite downward revisions, and the unemployment rate is historically low: 3.7%.
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Finally, he pointed to the Institute for Supply Management's manufacturing and services employment index, which has fallen deeply into the negative, which generally means unemployment will rise.
Bullandbearprofits.com/Trahan Macro Research
Wolfenbarger also points to recession indicators such as The Conference Board's main economic index and the inverted Treasury yield curve as evidence that a recession is looming.
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Wolfenbarger is in good company and believes the stock is in a bubble. Investment legend Jeremy Grantham, which called the crises of 2000 and 2008, has said since early 2022 that stocks are in a "super bubble." He reiterated those views in an interview with Business Insider in December and said bubbles take time to pop.
Adam Karr, president of Orbis Investment Management, also highlighted this point in his letter from the president 2023pointing out that the bursting of the dotcom bubble recorded two rallies of 35% and 51%.
Orbis Investment Management
Karr warned against investing in the "Magnificent 7" in the future despite their popularity.
"Collectively, the 'Magnificent Seven' added around $5 trillion in market capitalization [in 2023] โroughly equivalent to the entire Japanese stock market. Some of these gains are justified by the superior fundamentals these companies have produced, but there is a natural limit to how long they can continue at this astonishing pace," he wrote. "And to continue generating attractive returns, they will need to add many more "Japanese" " in market value in the years to come. "It's possible, but the odds don't seem convincing to us."
He continued: "Historically, similar periods have ended badly. Expensive stocks lost 40% of their value after the Japanese bubble in the late 1980s and 50% of their value after the dot-com implosion. Investors may look foolish for not owning the winners in the short term, and the 'FOMO' can be overwhelming. But paying too much for an asset with high expectations can be a recipe for disaster."
Most Wall Street strategists also believe Stocks will generally stagnate from hereif not it falls slightly.
But on the recession front, Wolfenbarger's view now runs counter to the consensus. According to Bank of America, 66% of respondents to the Global Fund Manager Survey see a soft landing ahead.
It is still too early for investors and the Federal Reserve to claim victory on the recession front, as the central bank leave high rates for now and the economy is beginning to show signs of slowing down. For now, the economy has held firm under the most aggressive rate hike regime in decades. Data in the coming months will tell if that strength continues or if Wolfenbarger's outlook proves correct.
