The Magnificent 7 value trade

Good morning. Armstrong here, back after a week in California. I can report that Los Angeles in January is a lot more pleasant than New York in January, and that the best song to blast out of your rental car window on Rodeo Drive is the Decemberists’ “Los Angeles, I’m Yours”. I’m not sure of the market relevance of either point, but there you go. Email us: robert.armstrong@ft.com and ethan.wu@ft.com.

The Mag 7 value trade

Market pundits often talk about the Magnificent Seven big tech stocks as a homogeneous entity. This is a mistake. Since the start of the pandemic, what the stocks have in common is that they have all risen quite a bit. But the dispersion of their returns has been very wide, as this chart shows: 

Amazon has barely outperformed the S&P 500, Nvidia has gone absolutely bananas, and the rest have covered the range in-between. What is more, the seven are very different, both as businesses and as stocks. Nvidia is a pure artificial intelligence play; Apple is a high-end consumer stock with defensive characteristics; Amazon is retailer-cloud computing hybrid; and so on.

These distinctions are visible in valuations and growth rates, too. A certain type of Wall Street observer talks about a Mag 7 “bubble”, but the valuations of Meta and Alphabet — two tech companies that make their money selling advertising — are quite close to the valuation of the market as a whole, and can boast expected growth far above the market average. If those two are in a bubble, the whole market is a bubble.

Bubble hunters might be able to make a better case against Apple or Microsoft: they look more expensive than the two advertisers, but without better near-term growth (in Apple’s case, growth is much lower). Amazon, Tesla and Nvidia offer more growth and even higher valuations (although when you scale Nvidia’s valuation to its near-term growth rate, using a PE/growth ratio, it surprisingly looks the cheapest of the group!). Putting the matter of bubbles aside, one can say that, at the very least, there is a rough value/growth split within the Mag 7, just as there is in the wider market.

All this leads to an interesting question: will Mag 7 growth, or Mag 7 value, do better in the next few years? Unhedged, in its picks for the FT stock picking competition, has already bet on value to do well in 2024. Happily, because the competition allows each journalist an entry, we got the chance, using Ethan’s slot, to double down on value with a Mag 7 relative value portfolio. The contest’s five-stock rule left us room to go long Google and Meta, and to short Microsoft, Nvidia and Tesla. (We left out Apple and Amazon because we wanted as pure a cheap-value-beats-expensive-growth portfolio as possible; Apple is expensive yet seems to be basically defensive rather then growthy, and Amazon’s valuation is hard to interpret because the company keeps its profit margins intentionally low.)

Is the resulting long-short portfolio one we would actually like to hold with our own money? Of course not! Betting against Nvidia and Microsoft is stepping in front of a momentum steamroller, and Tesla shares could do any damn thing. The risks are huge. But it is an interesting bet editorially, and in a year when value makes a comeback and AI hype subsidies, it might just do well.

We are keen to hear how readers would build their own Mag 7 long-short portfolio. Microsoft and Alphabet report earnings this afternoon; Apple, Amazon and Meta follow on Thursday. 

China’s ‘meh’ stimulus efforts

Writing about China poses two problems for a US-focused column like ours. First, US risk assets are relatively insulated from the Chinese economy. Second, it’s increasingly hard to fault a global investor for skipping a China allocation altogether; the unquantifiable political risks are daunting. Still, US investors can’t escape China’s impact. The price of oil is being kept down by weak Chinese demand, despite Opec production cuts. A strong Chinese recovery could also challenge the recent performance dominance of US equities, either directly or indirectly via Japanese or European assets.

Which is to say that Chinese growth matters, and so does the success of authorities’ efforts to stimulate the sluggish, deflationary economy. How’s that going?

The authorities are still trying to unjam the growth machine. The latest efforts include cuts to several policy interest rates and rule changes letting commercial property developers borrow to pay off old debts. The state is also intervening to prop up the stock market, which has fallen more than 20 per cent in the past year, such as with restrictions on short selling, tighter capital controls and mobilising state-owned enterprises to buy the dip. An Rmb2tn ($280bn) stock market “stabilisation fund” drawn from the offshore money of state-owned enterprises is reportedly being considered. All this is continuous with last year’s piecemeal stimulus push, which we described like this in August:

Faced with sagging demand and a teetering property sector, Chinese authorities have tried nearly everything. They have cut lending rates, mortgage rates, business taxes, stock-trading fees and even admission costs at tourist sites; extended EV subsidies; relaxed regulations; intervened in forex markets; and extended stock trading hours. The one thing they haven’t tried [is] fiscal stimulus.

Since then, we’ve seen more fiscal support. The central government announced Rmb1tn in surprise borrowing in the fourth quarter, which analysts think will raise China’s fiscal deficit above 3 per cent of GDP — loosely considered its red line. A separate Rmb1tn “special” bond issuance is under discussion too, reports Bloomberg. The central bank’s “pledged supplementary lending” programme, a quasi-fiscal facility for cut-price loans used in past stimulus pushes, increased the pace of lending 12 per cent in December.

But the picture remains a cobbled-together stimulus effort being rolled out in dribs and drabs. This is very different from the mammoth stimulus packages China has pulled off before. After the financial crisis, it spent Rmb4tn (nearly 13 per cent of GDP back then) building out infrastructure. In 2015-18, faced with slowing demand, it launched a multitrillion-dollar project to rebuild its slums. The contrast is stark: some analysts suggest today’s modest stimulus measures aren’t even being taken up. Despite the attempt to loosen financial conditions, corporate borrowing fell and loan rejections rose in January, according to a China Beige Book survey.

Why such a timid approach, then? The most convincing answer is official objectives coming into tension, as Goldman Sachs China analysts argue in a recent note. The best-known constraint is high local government debt levels limiting how much stimulus can be carried out through further borrowing. Goldman adds that differences in debt levels between cities muddy the fiscal picture: heavily indebted cities need to cut spending to pay down debt, while less indebted ones need to step up investment.

On monetary policy, the central bank’s ability to lower rates clashes with the competing goal of currency stability, since aggressive rate cuts would weaken the renminbi. Banks could be at risk too; lower rates would pinch net interest margins, already at record lows, without doing much to curb the pipeline of bad property loans. This helps explain why the People’s Bank of China, faced with a massive real estate bust, has only gradually cut rates, which remain well above 0 per cent.

The upshot from Goldman:

. . . multiple objectives and constraints faced by the government make policymaking more divergent and opportunistic: different cities and provinces adopt different approaches in managing property and local government implicit debt risks, and rate cuts are managed around Fed decisions and dollar movements, as well as bank net interest margins. As a result, the ongoing policy easing is perceived by the market as delayed, insufficient and uncoordinated. However, it is important to recognise that policy easing is ongoing and unlikely to stop until the real GDP growth target (which we think will be “around 5%” again in 2024) is secured, even if the precise size, form and timing have become extremely difficult to predict and a policy “bazooka” has become a thing of the past.

This reading makes sense to us. It suggests that the inflection point in China’s economy, and any risk assets that depend on it, may not be widely noticed when it happens. An opportunity for close China-watchers, perhaps. (Ethan Wu)

One good read

How the US could respond to Iran.

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