Peter Brown: Performance of many Irish pensions still tied to Apple and other big US stocks

The group of stocks known as the 'Magnificent 7' is on a massive bull run because of the hyped prospect of artificial intelligence

Apple is part of the 'Magnificent 7' which between them account for almost 30% of the S&P 500 index.

Following a dismal performance as inflation and interest-rate hikes hit markets hard, US and European shares rebounded strongly this year.

Inflation and the subsequent rapid rise in interest rates by the European Central Bank and the US Federal Reserve was the topic of the year, but from mid-summer when the high levels of inflation started to recede, there was growing optimism of interest-rate cuts early in 2024.

The stunning performance of the US stock indices — the S&P and Nasdaq — was, however, somewhat misleading. The group of stocks known as the “Magnificent 7”, which includes Apple, Microsoft, Amazon, Nvidia, Google-parent Alphabet, Tesla, as well as Facebook-owner Meta, between them account for almost 30% of the S&P 500 index. 

The seven stocks trade on an average price to earnings ratio of an enormous 47. If you buy that group of stocks, you are paying 47 years’ worth of current annual earnings. 

Paying a high price for something isn’t always a bad thing, but you must look at the price of a company relative to its growth rate to see if there is any real value there. If you buy a company at 50 times earnings, but it is growing at 150%, then it is cheap relative to its growth rate. If you pay 50 times earnings for a company growing at 25% then it is expensive relative to its growth rate. 

Large equity exposures

Most pensions and other passive general investment schemes in Ireland and elsewhere have large equity exposures to the seven stocks. US equity indices have the largest market cap in the world, so they get the highest allocation for that one reason alone. Price is what you pay, but value, or lack thereof, is what you get. When you pay a lower price for something, there is a higher margin of safety built into the investment.

The seven stocks are on a massive bull run because of the hyped prospect of artificial intelligence, or AI. We believe in AI as we did in the internet back in the 1990s, but that did not stop the Nasdaq from plunging back then when the market realised the hype was overdone. 

For the record, we are not negative on the Magnificent Seven in the long term but they are currently expensive and susceptible to a severe correction at some stage.

In Europe, we see a worse performance due to low economic growth, and the weakness of the German economy. Obviously, the Ukraine conflict does not help. Many will be surprised how the markets can rally with war raging in Europe and now in the Middle East, but wars mean more revenues for some companies. 

Fall predicted next year

We doubt the upsurge in the US stock markets can last, and predict a fall for specific stocks and markets next year, as the euphoria around falling inflation wanes. 

In the 1970s, inflation rose from 1972 to 1974 and then fell by the end of 1976, but only to roar back again in 1977. Central banks were again caught completely off guard, and I think it unlikely they will start to ease rates until they are very confident inflation is gone for good. 

In the longer term, we remain bullish on value equities, and on those with exposure to commodities, in particular. We continue to be bearish on the dollar and pretty much all other Western world currencies, due to reckless fiscal policies.

We are watching the US debt situation where we believe there is a major risk: The interest payments on US debt now exceed the whole of the US defence budget.

If, as we expect, inflation is not dead, we see great value in gold and commodities and we prefer green investment plays like carbon credits and uranium before tech stocks. 

• Peter Brown is managing director at Baggot Investment Partners [e-mail]