Chasing yesterday’s winners: A cautionary tale

The dominance of the “Magnificent Seven” and FAANG stocks within the NASDAQ-100 Index underscores their significant influence on the market, propelled by their high market capitalisations and impressive growth rates.

The “Magnificent Seven” which includes top tech giants Apple, Microsoft, Alphabet, Nvidia, Meta Platforms, Tesla, and Amazon, are among the world’s largest and most influential companies in the world. These entities (and their innovative products and services) have transformed the global economy and have consistently dictated market trends, with the NASDAQ-100 reflecting their tech-centric impact.

FAANG, an acronym for Facebook (now Meta), Apple, Amazon, Netflix, and Google (now Alphabet), represents some of the most prominent companies in the tech sector. These firms are known for their dynamic growth, technological innovation, and significant market presence, driving the performance of major stock indices.

The NASDAQ-100 is a stock market index that includes 100 of the largest non-financial companies listed on the NASDAQ stock exchange, heavily weighted towards technology. This index is significantly influenced by the performance of its largest constituents, notably, the tech giants, showcasing the tech-centric nature of modern financial markets. The NASDAQ-100 Technology Sector Index further emphasises the technological advancements and market movements controlled by these firms, cementing their role in shaping the future of the tech industry.

Yet, the exceptional performance of these stocks today does not guarantee their perpetual market leadership. Their high valuations and price-to-earnings (P/E) ratios indicate both success and inflated expectations, casting doubt on the long-term sustainability of their dominance.

In stark contrast, the Capped SWIX of the Johannesburg Stock Exchange presents a more diverse sectoral composition, reducing the risk of over-concentration as seen in indexes like the NASDAQ-100. It promotes a balanced market view, offering an alternative investment philosophy that eschews the tech-heavy bias.

The historical performance of the “Magnificent Seven” has spurred a rush towards these market leaders, driving up valuations and concentrating investment in a select group of tech giants. This trend raises concerns about market overvaluation and highlights the risks of dependency on a limited pool of companies for returns. Despite the success of these firms, the potential for market concentration risk looms large.

The performance dynamics between the Capped SWIX and the NASDAQ-100, where the former occasionally outperforms the latter, illustrate the fluidity of market leadership. The allure of current frontrunners is undeniable, but the rise of other sectors and regions, as evidenced by the Capped SWIX, showcases the potential for changing market dominance. This underlines the importance of diversification and a cautious investment approach to buffer against the volatility associated with a concentrated market.

The graphs below illustrate the concept of chasing yesterday’s winners. The contrasting performances between the NASDAQ-100 and the Capped SWIX below demonstrate why investors should be cautious about relying on current market dominators to ensure future success and outperformance.

Exhibit 1 | Chasing Winners – A cautionary tale of investment attraction

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Source: Fundfocus. Data as of December 2023. Past performance is not a reliable guide to future performance. For illustrative purposes only and not indicative of any investment.

Although it is tempting to pursue high-performing stocks such as the “Magnificent Seven” and FAANG, investors should proceed cautiously, with a keen eye on overvaluation and market concentration.

The seduction of short-term gains from these market leaders often detracts from the critical need for long-term investment stability and the value of a dynamic market perspective. Therefore, adopting a diversified and valuation-conscious investment strategy is paramount for maintaining financial wellness and navigating the complexities of evolving market landscapes. Only then can investors avert the pitfalls of performance-chasing for lasting investment stability.

Lusu Mpafa - OIG Invest

Author: Lusu Mpafa