With interest rates at 5%, can the "Seven Sisters" still support the US stock market?

A new round of earnings reports season is in full swing, and the seven tech giants are about to face the ultimate showdown with investors. As interest rates break through the 5% mark, the attractiveness of the bond market compared to the stock market is increasing day by day. Even if the "seven giants" deliver stronger-than-expected performance, can they still prop up the entire US stock market as they did in previous earnings seasons?

So far this year, the seven tech giants - Apple, Microsoft, Google, Amazon, Meta, as well as the newest members of this group, Nvidia and Tesla - have contributed almost all of the 12% increase in the S&P 500 index.

However, currently, the valuations of the "seven giants" have reached alarming levels, with an average expected P/E ratio of 33.5, far higher than the S&P 500 index's 18.3.

At the same time, the US bond market is also competing with the stock market for investors. US bond yields have reached the highest level in sixteen years, providing a risk-free return of 5% or even higher, which is far more attractive to investors.

Moreover, investors will not easily forgive companies that fail to deliver strong performance.

Tesla's first battle ended in defeat, the performance of the other six giants will be announced one after another

Tesla, the first tech giant to announce its earnings, has unexpectedly disappointed investors this time.

Tesla's revenue and profits for the third quarter were both lower than expected. CEO Elon Musk warned that the prospects for the production of the electric pickup truck Cybertruck were not optimistic. Tesla's stock fell more than 10% overnight, marking the largest intraday decline since January 3rd of this year.

"Everyone knows that these companies (the seven giants) will be profitable," said Sameer Samana, Senior Global Market Strategist at Wellington Investment Research Institute (WFII). "The only question is how fast this profit growth will be, and whether investors have overvalued it."

WFII downgraded its rating on the US information technology sector (including Apple, Microsoft, and Nvidia) from "value-added" to "neutral" in June.

Microsoft, Alphabet, Amazon, and Meta's earnings are expected to be announced next week, while Apple and Nvidia are scheduled to announce next month.

Overall, according to Dhillon, Senior Research Analyst at London Stock Exchange Group (LSEG), the "seven giants" are expected to see a 32.8% increase in earnings in 2023, while other companies in the S&P 500 are expected to see a 2.3% decline.

Interest rates reach a sixteen-year high, increasing attractiveness of the bond market

To make matters more complicated, as the expectation of a hawkish Federal Reserve continues to rise and the federal government faces the risk of a shutdown, interest rates and bond yields continue to climb.

High-growth and technology companies are more susceptible to the impact of higher yields because when investors can obtain higher returns from risk-free government bonds, the strong expected future cash flows of these companies are typically less valuable.

The benchmark 10-year US Treasury yield is currently at 4.947%, the highest since July 2007.

In response to this, Tim Pagliara, Chairman and Chief Investment Officer of CapWealth, said:

Investors didn't have a choice before, but now they do, and their allocations will be different. Future reallocation of funds will imply lower returns, making it more difficult for other giants to maintain their leading positions.

Are the "Big Seven" too expensive? Is it time for investors to short?

The outstanding performance of these giant stocks this year means that their market capitalization is also increasing. According to LSEG data, the combined market capitalization of the "Big Seven" exceeded 30% of the total market capitalization of the S&P 500 earlier this month.

According to the monthly survey released this week by BOCI Global Research, more than one-third of fund managers consider "being bullish on large-cap tech stocks" as the most crowded trade.

In a report, Torsten Slok, Chief Economist at Apollo Global Management, said:

The returns of the S&P 500 this year are completely driven by the returns of the seven largest stocks, and these seven stocks are becoming increasingly overvalued.

Of course, shorting the "market champions" is often unprofitable. The NYSE FANG+ Index, which consists of 10 stocks including the seven giants, has risen 140% since the end of 2019 before the pandemic, while the S&P 500 has only risen 33%.

Some investors have also made choices among these seven stocks.

Kaser, a fund manager at investment firm Brandywine Global, said the company holds stocks of Google and Meta, expecting these two stocks to generate substantial cash flows and be cheaper compared to similar giants.

They have been growing. But where does the growth come from, how stable is the expectation, and to what extent is it controlled by the company itself, there are significant differences among these seven stocks.