S&P 500’s Record Quarter And My Top Mag 7 Stocks

S&P 500 Closed At A Record In Q1

As we come to the end of the first quarter of 2024, it’s timely for us to assess the best opportunities ahead as we look ahead to Q2. Notably, the S&P 500 (SPX) (SPY) notched its best first quarter since Q1’19, as the market rose by more than 10% to close at the 5,254 level on March 28 (a record high).

As a result, the S&P 500 has delivered a breathtaking total return of almost 34% over the past year, well above its 5Y and 10Y average of 15% and 13%, respectively. Bearish investors would have you think that the day of reckoning could soon arrive as dip-buyers take profit and lock in significant gains, given the surge over the past year. After all, the S&P 500 is no longer that cheap, with the SPX’s forward normalized earnings multiple above 21x, well above its 10Y average of 17.5x.

Moreover, while NVDA is the standout performer of the Mag 7, delivering a YTD total return of more than 80%, three of its Mag 7 peers underperformed the S&P 500 over the same period: Google (GOOGL), Apple (AAPL), and Tesla (TSLA). Even Microsoft (MSFT) barely outperformed the SPX despite commanding a premium valuation of nearly 35x (forward P/E).

Beware Of The Momentum Trade

Given the bifurcation in performance in the Mag 7, what can we expect from these companies in Q2? Should we also anticipate a mean reversion of the S&P 500 after a remarkable Q1? Can earnings estimates sustain the market’s current valuation? Market strategists have penned in a median 2024 target of 5,200 for the SPX. If Wall Street strategies have their way, investors shouldn’t expect further upside to be recorded over the next nine months. What could stall the current momentum?

Astute investors should be cognizant that momentum is often “hard to die.” As seen with SPY’s “A” momentum grade, bullish momentum is a significant driving force. However, momentum swings could also be painful, as seen with the sharp pullback toward the S&P 500’s October 2023 lows preceding the considerable rally over the past five months. Therefore, momentum is a double-edged sword that could potentially untether the market’s advance if investors decide to lock in gains in anticipation of tepid returns moving ahead.

JPMorgan (JPM) cautioned investors that they “may be ‘stuck on the wrong side‘ of the momentum trade when it eventually falters.” As a result, investors must consider that “a sudden unwinding of momentum” could inflict significant pain. Despite that, it’s also crucial for investors to question whether JPMorgan’s house view still holds sway, as its “view on US equities has failed to materialize for two consecutive years.” While past performance should never be regarded as an indicator of future returns, I urge investors to be circumspect when considering what Wall Street strategists have to say.

As seen above, Bulls could point to the remarkable increase in forward earnings estimates driving the market’s returns over the past year. Therefore, while the SPX is valued above its 10Y average for now, further improvements in earnings estimates could underpin the ongoing rally.

However, there are also risks to the bullish thesis as global economic growth is expected to decelerate this year. While the Fed is expected to reduce rates three times this year, it’s also possible that the market could have priced in the optimism. Therefore, I believe investors must be careful about their asset allocation strategies, ensuring they don’t merely load into the momentum trades and discount valuation risks.

My Top Mag 7 Picks For Q2

What are my preferred picks from the underperforming Mag 7 stocks in Q2? Given the underperformance of GOOGL, TSLA, and AAPL in Q1, should investors expect the tide to turn more constructively for these three stocks in Q2?

We will get a closer look at Tesla’s Q1 deliveries over the next few days. Given the TSLA’s significant underperformance, I believe the market has priced in relative pessimism over its impending report. Furthermore, Tesla management has already cautioned that 2024 will be challenging as Tesla works on its mass-market vehicle.

Therefore, I believe the market will likely want to hear more encouraging soundbites from Elon Musk and his team to lift TSLA above the $175 level as it has struggled to shake off selling pressure. A worse-than-expected Q1 report could send TSLA re-testing the $150 level before a consolidation is expected. I view the risk/reward balance over TSLA as relatively balanced at the current levels, with a view toward more downside volatility.

Apple’s WWDC in June will be a highly anticipated event, perhaps more so than last year’s Vision Pro launch. With Apple’s generative AI strategies and efforts under intense scrutiny, the market will likely demand a robust approach from the Cupertino company as it looks to reclaim its throne (the world’s most valuable company by market cap) from Microsoft.

Apple’s potential partnership with Google is in the right direction, while its possible partnership with Baidu (BIDU) in China indicates the urgency of its go-to-market motion. Therefore, AAPL could benefit from a possible resurgence in Q2, even though near-term headwinds from the DOJ lawsuit could overwhelm buying sentiments.

AAPL has also tried hard to hold above the $165 zone over the past month. While the DOJ lawsuit scuppered an anticipated recovery over the past week, it hasn’t caused further damage to AAPL’s momentum, suggesting the support zone above the $165 level should hold. Therefore, I believe AAPL is priming for a Q2 recovery that should tie in with its generative AI launch at its June WWDC.

Google has been criticized for its AI efforts due to the recent faux pas concerning its Gemini launch. However, the market has shrugged off its stumbles as GOOGL buyers regained their composure, with GOOGL re-testing the $150 level.

Altimeter Capital also believes that “the wheels are starting to turn” for GOOGL as the Mountain View-headquartered company accelerates structural changes. Therefore, it underscored Google leadership’s emphasis on the need to make rapid changes to close the gap with the competition. Furthermore, GOOGL’s buying momentum (rated “A-” by Seeking Alpha Quant) seems to have turned the corner, lifting investor confidence. As a result, I believe GOOGL is well-placed to navigate a more constructive Q2 as it looks to shake off its relative underperformance.

Takeaway

As Q1 comes to a close, investors must not let past performance affect their view of potentially outperforming stocks in Q2. I indicated why AAPL and GOOGL could surprise their detractors as the market looks toward new anchors to turn their corners and broaden the market’s rally after closing at a record in Q1.