The new year’s first official trading day was this Tuesday — and it was a rough one for the Magnificent 7.

Analysts from Barclay downgraded Apple’s (Nasdaq: AAPL) shares, questioning the company’s sky-high valuations (which I spoke about here in Banyan Edge just a few weeks ago).

The downgrade triggered a cascade of selling that saw tech stocks lose over $235 billion in market cap before the day was done. Aside from Tesla, each of the “Magnificent Seven” mega-cap tech stocks dropped by 1% or more.

In other words, 2024 started with one of the worst trading days in months.

And it kept getting worse, with Roundhill’s Magnificent Seven ETF (Nasdaq: MAGS) losing nearly 5% during the first week of the year.

Shell-shocked investors and financial pundits seemed to respond with a collective groan and a “here we go again,” as worry spread that the recent rally might be coming to a close.

But it’s important to put this week’s stock performance in perspective — because it gives us a crucial glimpse at what could become 2024’s biggest profit opportunity…

Magnificent 7 to the Rescue

On the silver screen, the Magnificent Seven were a posse of gunslinging cowboys who rescued a small town from mustache-twirling villains.

In the stock market, the Magnificent Seven were the top-performing tech stocks that rescued investors’ portfolios in 2023.

These same tech stocks were some of the hardest hit by 2022’s downturn, and they bounced back fast — with average returns of over 111% across the top seven tech stocks (Facebook, Microsoft, Apple, Tesla, Nvidia, Amazon and Google).

Tech’s top seven mega caps now make up nearly a third of the S&P 500’s market cap. As I showed you in December, Magnificent Seven valuations are nearly twice that of the S&P 500 Equal Weight Index:

Magnificent 7 valuations

Astronomical valuations for Magnificent Seven stocks.

The Magnificent Seven are great stocks.

And they deserve to command some kind of premium.

But at these valuations, there’s just no room for error.

All it takes is one piece of bad news (this week it was a ratings downgrade from Barclay’s) to send shares tumbling from these dizzying heights.

We’ve seen it happen before with overpriced EV stocks, other tech stocks — even Magnificent Seven stocks. Facebook (Nasdaq: META) fell 26% in a single day after news broke about the failure of Zuckerberg’s metaverse.

At the end of 2023, Big Tech stocks were essentially “priced for perfect performance.”

As if investors assume all of this year’s boldest AI predictions will inevitably come true.

If and when those projections fall short, those who invested at today’s prices will be stuck with the bill in 2024.

I still recommend considering some stop-losses or other risk management measures for your Magnificent Seven holdings.

These mega-cap stocks aren’t likely to crash anytime soon.

But the upside of investing in these stocks is currently very limited. And it pays to be cautious when valuations reach these levels.

What About the “Not-So-Magnificent” 493? The Experts Weigh In…

It hardly comes as a surprise to see investors piling into the Magnificent Seven.

After all, top tech stocks have been some of this generation’s best performers. Investors have learned they can consistently count on stocks like Apple and Google for outsized gains.

Investors are also optimistic about rapid advancements in new technology like AI — which should boost Big Tech stocks even higher.

But after 2023’s bear market, investors are still somewhat risk-averse. They want to stick with well-known and “safer” mega-cap stocks.

All of these factors contributed to a “perfect storm” for top tech stocks over the last year, with a stampeding herd of investors piling into the Magnificent Seven. Hence their sky-high valuations.

Some experts, like Goldman Sachs’ David Kostin, believe the Magnificent Seven will continue to outperform in 2024.

Kostin points out that there’s no real return relationship between the Magnificent Seven and the other stocks in the index.

So while it might seem natural to expect the other 493 will soon catch up, Kostin argues there’s no clear precedent for it.

“There has been no reliable historical relationship between the trailing and forward 12-month outperformance of the largest seven S&P 500 constituents vs. the remainder of the index,” he explained in a recent note to investors.

Kostin pointed back to 2020 and 2021, two consecutive years in which mega-cap tech stocks trounced the competition.

Matthew Bartolini from State Street argues that we’ll see a change-up in the Magnificent Seven’s roster for 2024.

He believes Facebook (Nasdaq: META) and Tesla (Nasdaq: TSLA) will be replaced by a pair of new top performers — ExxonMobil and Berkshire Hathaway.

“Given how it’s more probable than not that market breadth won’t be as concentrated in 2024, sector allocations are likely to rise alongside the increased return dispersion,” Bartolini explained.

In other words, investors were more focused on surviving 2023 … where they’ll be aiming to thrive in 2024.

Bartolini is onto something there, too.

Two Paths for the Magnificent 7 in 2024

As investors regain their appetite for risk, you can expect them to start reaching for smaller and more innovative companies. These companies’ stocks are inherently more volatile than mega-cap tech giants, so they’re capable of much faster gains.

And once other investors begin to see and hear about those fast-moving gains, you can expect the fear of missing out (aka “FOMO”) to start kicking in.

But I’m reminded of the wisdom of John Maynard Keynes, who once said: “The market can stay irrational for longer than you can stay solvent.”

Kostin may be correct…

In my opinion, Magnificent Seven valuations are already too high.

But as you may recall, valuations reached much higher levels during the dot-com bubble (Nasdaq price-to-earnings ratios reached over 200 at the time!), so the Magnificent Seven might have more room to run.

At the same time, investors are still anxious to see returns. And they’re nervous about seeing another downturn.

So it’s unlikely they’ll sit through many more rough weeks (like this one) for their top stocks without starting to consider alternative investments.

And right now, there are plenty of appealing alternatives…

(You can learn more about my top “non-Magnificent Seven” investments HERE.)

To good profits,

Adam O’Dell

Chief Investment Strategist, Money & Markets