Magnificent Seven lose $1.1 trillion in market cap in six days

• Magnificent Seven's combined valuation is down 8% from recent all-time high of $14 trillion
• They are still valued at $12.9 trillion, or 31% of the S&P 500 index
• Investors will look to latest round of quarterly results for reassurance
• Rising bond yields, and a steepening US yield curve, could also be exerting influence

"The so-called Magnificent Seven of Alphabet, Amazon, Apple, Meta Platforms, Microsoft, NVIDIA and Tesla have shed $1.1 trillion of stock market value in the last six trading days in the USA and investors will be looking to six of them for reassurance when they report quarterly numbers in the next two weeks (NVIDIA is the exception and will publish on 22 May)," says AJ Bell investment director Russ Mould. "Weak iPhone sales data, poor delivery numbers from Tesla and regulatory pushback in the EU and the USA may all be weighing on sentiment, but the impact of the markets' view on the direction of interest rates cannot be underestimated, either.

Source: LSEG Datastream data

"One of the most intriguing facets of financial markets over the past two years has been the differing messages offered by bond yields and share prices. The bond market, via the so-called inverted yield curve, has been predicting a recession. The stock market has instead priced in a cooling in inflation, a gentle economic landing and a pivot to interest rate cuts from central banks, with the result that headline equity indices from America to Australia, France to Taiwan and Canada to Germany have set new all-time highs.

"Normally, the yields on long-term bonds are higher than those on short-term paper. This is simply because lenders (or bond buyers) demand a higher return to compensate themselves for the increased scope for something to go wrong during the additional time, such as changes in interest rates, higher inflation or, at worst, a default by the issuer (or borrower).

"The usual shape of the yield curve therefore goes from the bottom left of a screen to the top right, in a gently steepening path, although right now, the US yield curve is inverted.

Source: LSEG Datastream data

"An inverted curve means long-term rates are lower than near-term ones. This means markets think that interest rate cuts are coming in response to a slowdown or recession. A shorthand version of this can be provided by comparing just the yield on two- and ten-year government bonds.

Source: LSEG Datastream data

"But the yield curve changes shape according to variations in the yield on each individual maturity, as it flattens or steepens, and there are four possible scenarios here:

• A bull flattener,when long-term yields (and interest rates) fall faster than short-term ones, so the yield spread shrinks. This is usually how markets discount interest rate cuts and can be seen as positive for bond prices (as yields fall) and share prices (as a recovery in profits, dividends and cash flow is anticipated). The longer the duration the more favourable it is, and this can include assets such as long-dated bonds and equity sectors with a big chunk of their earnings in the future, like technology and biotechnology.
• A bear flattener, when short-term yields rise faster than long-term ones, so the difference between the two again narrows. This is usually seen as a harbinger of recession, or at least interest rate hikes and tighter monetary policy, and is thus potentially negative for share prices, especially for areas like banks and cyclicals.
• A bull steepener, when short-term yields fall faster than longer-term ones, so the spread, or differential between them widens. This is usually seen when markets are pricing in interest rate cuts and is thus bullish for bonds and equities.
• A bear steepener, when both short- and long-term yields are rising but long-term ones are rising faster to widen the gap between the two. This can be bad news for bonds in particular, as prices fall when yields rise, and it can be a sign inflation is on the rise. It could be a challenge for share prices, too, as it combines higher discount rates (that lower the theoretical value of the long-term cash flows of long duration sectors like tech and biotech) with tighter monetary policy that hits the earnings power of short-duration, cyclical industries

"Right now, we have a bear steepener on our hands in the USA.

Source: LSEG Datastream data

"If the US economy slows down, then there could be trouble ahead for equities. But given the amount of fiscal stimulus being applied, that does not seem so likely for now, almost irrespective of who wins the US Presidential election in November. The issue at hand could therefore be inflation instead, especially as the Biden administration is on course to add $7 trillion to America's national debt during its four-year term (and the total deficit only reached that level for the first time in 2003).

Source: LSEG Datastream data, FRED - US Federal Reserve database, Congressional Budget Office

"That does not mean it is game over for the stock market's bull run.

"It could mean a more difficult environment for bonds and yield-offering bond proxy stocks like utilities and consumer staples.

"It could mean a more difficult environment for long-duration sectors like tech and biotech, and this may help to explain why the Magnificent Seven's market valuation has suddenly sagged (even if the six-day, 8% fall means they still have a combined valuation of $12.9 trillion, or 31% of the S&P 500).

"It could mean a more interesting environment for companies with pricing power and also commodities, if investors repeat the 1970s' strategy of looking toward 'hard assets' as a store of value relative to paper ones, such as cash and bonds, the real value of which may be eroded by the ravages of inflation.

"The bond market could just be flat out wrong. It has wrongly been predicting a recession. It is now predicting inflation. But the signals emanating from bonds still do not sit easily with the equity markets' preferred narrative of cooling inflation, slow growth and interest rate cuts.

"And perhaps we are asking the wrong question, as we search for a reason for this sudden air pocket in the Magnificent Seven's previously serene trajectory. As J.K. Galbraith wrote in his book The Great Crash, the issue may not be why stock prices are falling, but why they trade at such elevated levels and valuations in the first place: 'The least important questions are the ones most emphasised: What triggered the Crash? This is not very important, for it is in the nature of a speculative boom that almost anything can collapse it.'

"Equally, it may just be that - an air pocket - and a strong set of quarterly numbers may offer the necessary reassurance, although Netflix's robust Q1s did little to support its share price last week."

Magnificent Seven reporting calendar:

Source: Company investor relations websites. Alphabet, Amazon, Meta Platforms have December year ends. NVIDIA's fiscal year runs to January. Microsoft's fiscal year runs to June. Apple's fiscal year runs to September.