Nvidia and the rest of the Magnificent 7 create a risky scenario for the market, strategist says
Andrew Krei, co-chief investment officer at Crescent Grove Advisors, spoke with Quartz for the latest installment of our “Smart Investing” video series.
Watch the interview above and check out the transcript below. The transcript of this conversation has been lightly edited for length and clarity.
ANDY MILLS (AM): Nvidia reports earnings on Wednesday after the bell. Sometimes even when they surpass expectations, the markets are unhappy, do they have to have blow out earnings for the markets to react positively?
ANDREW KREI (AK): It speaks to the idea that whether you look at the valuation or the assumptions that go into Nvidia’s (NVDA) price are ultimately a high bar, right? The market is expecting that this AI growth theme continues for quite some period of time, that Nvidia continues to capture a large portion of market share, that their margins stay very healthy where they are now. And if there’s any sign that that story or that narrative is breaking in, in some way, shape, or form, then I think again, investors look at this with a very high bar.
If Nvidia can’t exceed that bar, to your point, there’s disappointment around that. And I think it speaks to the broader AI theme as well. And some of the other companies that have been the poster children, the Magnificent Seven, those mega-cap tech names that have benefited from that narrative, just this idea that going forward, valuations are really demanding. Expectations are really demanding in terms of what investors are looking for around their execution on these themes.
If they don’t meet those high bars going forward, they can’t exceed those, then that’s where you see the knee-jerk reaction of people selling off these stocks because that uncertainty starts to exist to a greater degree than where it has been before.
AM: The majority of the growth in the indexes has been in the Mag Seven over the last couple of years. What risk does such market concentration pose?
AK: I would say if you look historically at episodes where you have a significant amount of concentration at the top of markets, meaning the top 10 names or so, what they represent is a percentage of the aggregate market cap. Right now we’re in the 30% range, mid-thirties, something along those lines generally doesn’t end well, right? There’s just a huge amount of piling into these names that happens from investors that you create this momentum that begets buying, begets more buying, that sort of thing.
Ultimately, when there is a reversal, of course, if the narrative does start to break, again, go back to the AI theme, right? If the execution isn’t absolutely spot on going forward, when you start to extrapolate the assumptions that are built into these stocks, that’s when you can start to see a wave of capital outflows from these names. And that’s again, historically speaking, what you’ve seen now are these businesses, they’re phenomenal businesses, right?
I think it’s warranted the idea that their growth has exceeded the rest of the market and they’ve again, I think, been deserving of the status to be market leaders. When you look at the relative earnings growth over the last several years from our perspective and as we look forward and we think about investors, the basic portfolio management principles that we go to, we think about diversification and sort of this idea of how do you avoid some of those concentration risks.
For us, it’s taken some chips off the table, rebalancing into other segments of the market that now the earnings growth picture starts to look a little bit more favorable. The expectations are coming down a little bit for earnings growth for the likes of Nvidia and Microsoft (MSFT). The Magnificent Seven and earnings growth potential is ticking up for the, let’s call it “S&P 493”, the non-Magnificent Seven names.
I think gives us the specter of a potential convergence in performance going forward, if not an outright rotational opportunity for investors, relative value going from something really highly valued to something that’s more reasonably valued in the market with fundamentals now that, again, start to converge a little bit. So that to us is the way to play it. But again, it’s been deserved, I think for the Magnificent Seven to see the gains that they’ve seen.
AM: So in the other, the S&P 493, are there any sectors or companies you’re looking at that investors should consider investing in?
AK: How we kind of frame it up is there’s tech, there’s the Mag Seven, the mega cap tech names, and then everything else. So there’s that very, very high-level taxonomy for us, and I think we just want to be a little more focused on the everything else bucket over the next, you know, 12-plus months and thinking about that relative value, rotation opportunity.
But even within that, I would say value segments of the market. So that can be things like industrials, materials can be even things like consumer staples, healthcare, just these sort of segments that have been a little bit left for dead in some respects over the last several years because their earnings have been kinda middling. The growth hasn’t quite been there to the same magnitude that the tech earnings growth has been. We just think, again, there’s an opportunity for capital to flow into those segments.
In particular, if we look at that forward-looking picture for the new administration, if there is gonna be more fiscal stimulus, if there’s gonna be deregulation, financials a big piece of the value index. You look at these other segments that could benefit from this pro-cyclical type of growth backdrop that we could see going forward. And that to us represents a compelling proposition relative to, again, these tech names that have done so well and now trade at really demanding valuations.
