Investors who are patiently observing the artificial intelligence and Magnificent Seven stock “bubble” to gauge its potential bursting would be prudent to delve into historical market patterns. According to Bank of America’s team of strategists, spearheaded by Michael Hartnett, analyzing similarities and distinctions between past bubbles and the current scenario is crucial. The team suggests that a surge in real interest rates is likely to be the eventual trigger for the downfall of this group of stocks.
Following the significant surge in the stock prices of seven prominent Big Tech companies last year — including Tesla Inc., Microsoft Corp., Apple Inc., Amazon.com Inc., Alphabet Inc., Nvidia Corp., and Meta Platforms Inc. — the upward momentum continues for many of these firms, along with other technology entities.
Bank of America has provided a chart that juxtaposes historical bubbles such as the South Sea and Mississippi bubbles from the 1700s, the roaring 20s for the Dow industrials, the dot-com bubble of the 1990s, with the current run of the Magnificent Seven:
While each bubble is unique, there are key similarities that can be used to assess the current situation of the Magnificent Seven, such as catalysts, price movements, valuations, and the ‘price of money,’ as highlighted by Hartnett and the team.
Regarding catalysts, the strategists note that previous bubbles were fueled by technological advancements, new growth sources, and crucially, central bank interventions — a narrative that resonates with the present scenario.
The price factor, measured by asset gains from trough to peak, shows that the 140% increase in the Magnificent Seven stocks over the past year is approaching the gains seen in the 1920s for the Dow industrials and the surge in the Nifty 50 blue-chip stocks during the early 1970s. However, it still falls short of the 230% upsurge witnessed in FAANG stocks post the COVID-19 pandemic lows.
In terms of valuation, the Magnificent Seven group’s price-to-earnings ratio stands at 45, which is relatively lower compared to most historical bubble peaks.
The critical factor that could potentially lead to the downfall of the Magnificent Seven is the “price of money.” Analysis of past bubbles reveals that rising bond yields and tightening financial conditions coincided with the peak or burst of these bubbles. For instance, the internet bubble burst when real rates hit 4%, China’s stock bubble deflated at 2%, and the subprime bubble was punctured at 3%.
Given the current elevated levels of global debt and 10-year real rates at 2%, Hartnett and his team anticipate that rates between 2.5% to 3% could spell the end of the AI and Magnificent Seven era.
Despite potential warning signs, investors appear undeterred, with technology stocks and corporate bonds emerging as favored asset classes. Technology sector funds have garnered substantial inflows this year, signaling a positive trajectory for these sectors amidst the evolving market landscape.
