The Best Of Times And The Worst Of Times: A Tale Of Two Stock Markets

It was the best of times, it was the worst of times. It was the age of wisdom, it was the age of foolishness. It was the epoch of belief, it was the epoch of incredulity. It was the season of light, it was the season of darkness. It was the spring of hope, it was the winter of despair.

–Charles Dickens, A Tale of Two Cities

I’ll be honest with you: I couldn’t get through Dickens’ famous novel, A Tale of Two Cities, in high school. Perhaps it would have been gripping to an 1860 Londoner, but to a mid-2000s American teenager, it couldn’t have felt more tedious and inscrutable.

Perhaps the greatest contribution to the world made by Mr. Dickens’, along with Shakespeare and others, was to fuel the rise of SparkNotes and other chapter summaries of high literature.

The real “tale of two cities” is the disparity between how much high school English teachers seem to love Dickens versus how much teenagers hate it.

Now, with that off my chest, I must admit that Dickens’ opening line is a powerful and poetic expression of the great disparities that exist in the world. It feels true of many things: two extremes, side by side, veiled by the tyranny of averages.

That, I would argue, is exactly the situation we find in the stock market today.

Compare, for example, the performance of the Magnificent 7 (MAGS) to that of out-of-favor sectors like real estate (VNQ), energy (XLE), and utilities (XLU) over the past year:

It has been surprising to see the degree to which Big Tech increasingly luxuriates in oceans of cash while traditionally defensive sectors fight for measly scraps.

As I acknowledged in “The Magnificent 7 Dividend Stocks For 2024,” the Magnificent 7 mega-cap companies truly are magnificent.

This was demonstrated most recently in Nvidia’s (NVDA) magnificent Q4 2023 earnings release, in which CEO Jensen Huang highlighted generative AI as a burgeoning technology being adopted by all kinds of industries (auto, healthcare, financial services, robotics, etc.) to streamline operations and boost growth.

Generative AI and large language models are clearly more than just hype. They are producing massive profit growth for industry leaders like NVDA. NVDA’s EPS nearly quadrupled from 2023 to 2024.

While such wild success inevitably attracts competition, and the largest constituents of stock indices rarely remain the same from decade to decade, it does not look inevitable that the Mag 7 will soon be cut down to size. Quite the opposite. Their reign, certainly for the superstars in generative AI like NVDA, does not appear to be ending anytime soon.

In what follows, I’ll discuss some charts showing the extreme disparity present in the stock market today. Then I’ll take a look at how my “Magnificent 7 Dividend Stocks” from the above-linked article are performing against the Mag 7 year-to-date. (Preview: It ain’t pretty.)

The Spring of Hope and Winter of Despair

The technology sector has not made up this much of the overall stock market (by market cap weighting) since… you guessed it… the dot-com bubble of 2000.

At the same time, defensive sectors like utilities, consumer staples, and healthcare have not been such a small portion of the broad market since the dot-com bubble.

Over the last year, the vast (and I mean vast) majority of stock sector fund inflows have gone into tech.

Communications (VOX) has enjoyed some inflows primarily because of names like Meta Platforms (META), Alphabet (GOOGL), and Netflix (NFLX) — all up massively over the last year. Industrials (VIS) have likewise held their ground.

All other sectors have seen net outflows over the past year.

We haven’t seen such famously spectacular performance from an iconic group of stocks since the “Nifty Fifty” of the late 1960s and early 1970s. Back then, the prevailing attitude was that the Nifty Fifty were really all you needed to own as an investor. That attitude seems to be present today as well.

The Mag 7 currently account for about 33% (1/3rd!) of the S&P 500’s total market cap.

You can see that at the peak of the 2022 selloff, Berkshire Hathaway (BRK.A, BRK.B) ascended into the top 5 largest companies by market cap. Some green shoots of value began to appear. But when tech rallied in 2023, the reign of growth over value promptly resumed.

The debate between value and growth investors is whether today’s situation “rhymes” with that of the dot-com bubble or not.

The value camp says yes, today’s generative AI hype is similar to the Internet hype of the late 1990s. And, they say, while the tech sector sucked up all the oxygen in the room back then, virtually every sector benefited from the adoption of the Internet. The same will hold true with generative AI. Investors are throwing their money at a handful of tech companies at the forefront of the AI hype, but all kinds of companies and industries will end up benefiting from the commercial adoption of AI. The Mag 7 will eventually go through a period of underperformance just like the Nasdaq index (QQQ) did after the dot-com bubble burst.

On the other hand, the growth camp says no, today’s situation is very different than the Internet hype cycle of the late 1990s.

Unlike today’s Nasdaq index P/E ratio of about 27x, the index sported a nosebleed P/E ratio of about 175x at its peak in March 2000.

Today, unlike then, mega-cap companies are rapidly turning hype into profit growth, which results in the Mag 7 having a lower PEG ratio than the whole S&P 500 index (SPY) or the MidCap S&P 400 index (MDY).

In fact, while the chart below is a bit dated now, it does show the incredible divergence between earnings estimates trending upward for the Mag 7 and downward for the rest of the SPY.

It is the best of times in the techy AI world, and it is the worst of times in most other parts of the stock market, especially cyclical industries and interest rate-sensitive companies.

Since the beginning of 2022, mentions of weak demand (and variations thereof) have soared to levels reserved only for recessionary periods.

The Fed’s “higher for longer” regime has been punishing for business models that rely heavily on the use of debt, most notably commercial real estate.

In the realm of REITs, refinancing debt maturities is pressuring earnings at the same time as tenant demand is receding and a wave of new supply is coming online.

Utilities are shouldering the burden of higher interest costs from both debt refinancing and new issuance to fund aggressive capacity expansion.

Consumer staples are reaching the end of the significant price hikes that consumers can or will bear while simultaneously fighting off low-margin, private-label competition and trying to deleverage.

And the housing market, along with the many industries it supports, is languishing from the lowest home sales volume since the Great Financial Crisis of 2008-2009.

In other words, a great many industries and sectors face a shortage of cash and are seemingly “fighting for scraps.”

At the same time, weakness across a broad swathe of the economy and business world is masked by the tyranny of averages. For example, one might point to this chart to illustrate the fact that corporate America is doing better than ever and has plenty of cash in the bank:

But the majority of this cash is held by a relatively small number of companies, mainly in tech, insurance, and investment banking.

The Mag 7 companies alone account for over 10% of total US corporate cash holdings.

This cash is now generating interest at over 5% yields, which plays a role in the Mag 7’s tremendous outperformance during the Fed’s rate hiking cycle.

Consider, for example, that Alphabet’s ~$111 billion in cash could be generating about $5.5 billion in annualized interest. That represents about 7.5% of the company’s trailing twelve month net income!

“Higher for longer” greatly benefits the Mag 7 and greatly hurts many other parts of the economy.

A Humble Dividend Investor’s Perspective

I am not an investor in the Mag 7, besides some small exposure to three of them through the WisdomTree US Quality Dividend Growth ETF (DGRW).

I am not a Mag 7 denier, either. I acknowledge that they are, by and large, fantastic companies with strong growth prospects.

But some are better valued relative to their growth prospects than others. For example, if you break out the Mag 7’s price-to-earnings growth (PEG ratio) by individual company, you’ll find wide variation between Apple’s (AAPL) ~3.2x and NVDA’s 0.1x.

If the PEG ratio is to be trusted, then perhaps AAPL’s stock is overhyped while NVDA’s is (brace yourself) underhyped, despite the fact that NVDA has vastly outperformed AAPL over the last year.

All I am saying is that perhaps some members of the Mag 7 are more deserving of their rich valuations than others.

Now, what about my (so far, ill-fated) bet on the “Magnificent 7 Dividend Stocks” to beat the Mag 7 in 2024?

I won’t lie. It hasn’t turned out that well so far.

Verizon (VZ), of all stocks, briefly outperformed the Mag 7 in January, only to be overtaken in February.

But I continue to believe that once the market can see the whites in the eyes of Fed rate cuts, beleaguered sectors like REITs, utilities, and other dividend stocks should enjoy their time in the sun again.

If you look at the two-month period at the end of 2023 (I know it’s not a large sample size), dividend stocks’ performance was far more respectable against the Mag 7.

The Mag 7 still beat most of my Magnificent 7 Dividend Stocks, but the debt-laden Brookfield Renewable (BEP, BEPC) and medical device maker Medtronic (MDT) both outperformed, and high-quality net lease REIT Agree Realty (ADC), which the market treats like a bond proxy, was right on the Mag 7’s heels.

Does this group of dividend stocks have any chance at overcoming their early-year deficit and staging a comeback to outperform the Mag 7 for the balance of the year?

I think that will heavily depend on what the Fed says and does over the course of the year.

For now, we dividend investors are still mostly living in the “worst of times.”