There’s a scene in the iconic 1960 Western The Magnificent Seven where two mercenary gunslingers—played by Steve McQueen and Yul Brynner—muse on the plight of the villagers they have been hired to protect. 

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McQueen says to Brynner—“Reminds me of that fellow back home that fell off a ten story building.”

“What about him?” asks Brynner.

“Well,” says McQueen, “as he was falling, people on each floor kept hearing him say, 

‘So far, so good.’”

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Doesn’t that just perfectly capture the hopeful pessimism permeating our markets? 

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And just as hopes of a village afflicted by bandits rested on the broad shoulders of these seven horsemen—so do the hopes of the markets—afflicted as they are by high interest rates—rest today on the shoulders of the Magnificent Seven.

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In the context of the markets, the Magnificent Seven refers to a band of market-leading stocks —Apple (AAPL.O), Microsoft (MSFT.O), Alphabet (GOOGL.O), Amazon (AMZN.O), Nvidia (NVDA.O), Tesla (TSLA.O) and Meta Platforms (META.O). 

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Zuck and Musk…not exactly Brynner and McQueen. But it’s true—if it weren’t for this collection of “megacap” stocks—the whole village would already be in a heap of trouble. 

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A Tale of Two Markets

One of our recurrent themes over the last few months has been the seemingly impossible dichotomy in our economic outlook.

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At once, recession seems inevitable and unthinkable. 

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On the one hand, treasuries are getting killed. The yield curve is inverted. And long term bonds are in the shitter.

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On the other hand, the S&P 500 is up more than 12% on the year. Investors keep investing. The markets keep churning. Big wheel keep on turning.

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On one hand, consumers are accumulating debt and struggling to catch up after two years of punishing inflation.

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On the other hand, consumers are still consuming. Inflation has returned to a tolerable if imperfect 3.70%. (Remember—we were at 8.20% just last year.)

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On one hand, the Federal Reserve has toggled up interest rates at record speed as housing prices exceed the reach of many Americans. 

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On the other hand, maybe the Fed won’t raise interest rates again…maybe.

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So it’s easy to see why we’re not getting any clear visions by reading the usual tea leaves. Without getting too technical on you—COVID made shit weird. What led us here was hardly predictable. So where it all leads has also been impossible to predict. 

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Fortunately, we have smart friends to help us with that. 

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The Sun Will Come Out Tomorrow…Or Possibly closer to the end of 2024

On this week’s episode of Let’s Talk Markets, we were joined by our good pal Dennis Dick from Benzinga. Those who recall last month’s conversation with Dennis will remember that things were looking pretty grim out there. With the approach of Halloween, Dennis noted that investors were spooked by foreboding signs on the horizon, particularly the looming threat of yet another interest rate hike.

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Just one month later, Dennis returns to us with a touch of sunny optimism as we barrel toward the holiday season. We weren’t expecting it, but on the approach of Thanksgiving, we sure are grateful for some cheery news.

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Ok, so on to the good news…*shuffles papers*.

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The Equal Weight S&P 500 is down on the year, with roughly 300 of its stocks losing value in 2023. Hmm. That sounds bad, right?

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So where is the good news, exactly? Well, it turns out that all the good news is bunched up at the top. On the surface, the S&P 500 is actually crushing it. The leading index is up nearly 10% on the year. So how is that even possible—that losses across the vast majority of listed stocks aren’t dragging down the entire market?

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Well, for that, we have the Magnificent Seven to thank.

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Reuters reported just the other day that, according to chief economist at Apollo Global Management, Torsten Slok, "Returns this year in the S&P 500 have been driven entirely by returns in the seven biggest stocks, and these seven stocks have become more and more overvalued.”

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Overvalued though they may be, Reuters points out that investors rarely win when betting against the “market’s champions.” Moreover, the outsized role these champions have played in shaping markets isn’t necessarily a new phenomenon. 

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Reuters points out that “The 10-stock NYSE FANG+ index (.NYFANG), which includes the Magnificent Seven, has gained 140% since the end of 2019 before the pandemic, versus a 33% gain for the S&P 500.”

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Simply stated, these megacap tech stocks are performing so robustly that they’re draggiing the market along with them, this in spite of the fact that the small cap stocks are either drowning in debt, or getting ready to refinance, so that they can subsequently drown in debt. 

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When you hold the two sides of the market up against one another, it makes sense that we’re feeling hopeful pessimism. Like the man falling from a ten story building, we know things aren’t going totally right, but we’re still thinking maybe it all turns out for the best. 

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The Recession Regression

“I think there’s hope,” Dennis told us. 

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That we avoid a recession altogether? No, probably not. 

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But it is possible that we do experience that fabled soft landing—a perfect confluence of factors where the job market cools just enough to prevent a spike in inflation; where the Fed not only resists the temptation to raise interest rates again but even considers scaling downward in the coming year+; where we avoid the catastrophic market failures of the Great Recession.

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That doesn’t mean there won’t be pain, or that there isn’t already. As Dennis tells us, the events that are likeliest to tip us into recession have already occurred. There is a lag between macroeconomic events and the way we experience them in our everyday lives. To wit—it’s hard to convince the average American that inflation has returned to near normal rates. Bread and butter still cost a stupid money. 

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Today, that lag is placing high debt and high interest rates are on a collision course. The eventuality of impact means a near-certain economic slowdown.  

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The Village of the Damned

And this underscores a core difference between the Magnificent Seven and the villagers, those 300 flailing stocks rounding out the S&P 500. 

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Companies carrying debt, either their own or the debt they finance on behalf of their customers, are facing a reckoning. Take solar stocks for instance. The very nature of their business depends on the ability to borrow on behalf of their customers. In other words, the average solar operation rests on a foundation of debt. 

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At the time of writing, the 10-year APR for refinancing stands at 7.28%. Solar companies will be hit hard when it comes time to refinance. These same interest rates will greet prospective new customers, many of whom will be forced to think twice about making that type of investment today. 

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Meanwhile, Apple is still out there giving away iPhones at 0% interest. From the consumer’s perspective, that is comparatively magnificent. And it underscores a point—Apple’s business model isn’t built on debt. They are built to perform even in the face of maddening interest rates.

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Will the Magnificent Seven Save the Day?

Well, no. But they’ll definitely save themselves.

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If you’ve ever seen the Magnificent Seven–the movie–you know that the heroes get mixed results. I don’t want to spoil anything, but not everybody lives. Reuters reports that the Magnificent Seven–that megacop stocks–are up 32.8% on the year. Everybody else in the S&P 500 combines for a 2.3% decline. 

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These seven stocks make up 30% of market share!

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So overall, the index skews higher on their strength. But just as the holiday season is upon us, so too is the 3rd quarter earnings season. Some of the numbers have been less than stellar for the Magnificent Seven. 

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Tesla saw a 7% drop in the value of its stock in mid-October, just after its quarterly earnings reports fell short of Wall Street estimates. At present, the Magnificent Seven have fallen off 15% in value collectively from their 52-month high. 

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Of course, at this point, they’re playing with house money. The Magnificent Seven are up for the year, and then some. 

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But the fall off doesn’t portend well for the rest of the index. Again, these riders are built to weather the storm. In the coming (or possibly current) recession, however soft the landing may or may not be, those small cap companies carrying big time debt may well be casualties. 

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All villagers take heed.