Could 7 tech giants drag down the broader market?

October 31, 2023 at 06:10 AM EDT

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You don't hear so much about the Magnificent Seven tech stocks anymore as the S&P 500 has been selling off since August.

That group consists of Apple Inc. (NASDAQ: AAPL), Microsoft Corp. (NASDAQ: MSFT), Alphabet Inc. (NASDAQ: GOOGL), Amazon.com Inc. (NASDAQ: AMZN), Nvidia Corp. (NASDAQ: NVDA), Tesla Inc. (NASDAQ: TSLA) and Meta Platforms Inc. (NASDAQ: META).

Together, those seven growth stocks are responsible for the bulk of the S&P 500's 9.23% year-to-gain. As you can imagine, they're all heavily weighted in the S&P 500.

Now that earnings season is upon us, the market will get more insight into whether these stocks will continue driving a rally.

However, because of their heavy influence over the broader S&P 500, the maybe-not-so-magnificent-after-all Seven have the potential to drag down the broader index.

The market has been down this exact same road, and not that long ago. A look at the SPDR S&P 500 ETF Trust (NYSEARCA: SPY) chart shows the index rolling over just at the beginning of 2022, following a huge pandemic-era uptrend.

Techs led the market lower in 2022

As tech stocks sold off in 2022, they led the broader market.

Is history about to repeat?

As of now, the divergence between their performance is showing up. Alphabet earnings beat views, but the stock is still down nearly 10% in the past week as revenue at its cloud business came in below estimates.

Meanwhile, Microsoft's earnings report indicated that AI is contributing to its cloud-business growth, as the company is seeing rising demand for AI tools.

Microsoft stock is up less than 1% for the week.

Fading EV boom drives Tesla lower

Tesla earnings and revenue missed views as the EV boom is fading. The stock fell 15.58% the week ending October 20 and another 2.58% the following week.

Meta earnings and revenue also exceed Wall Street views, although it also issued conservative guidance, causing the slide to slide 4.25% for the week.

Apple reports on November 2, and AI chip titan Nvidia is due to report on November 21.

There's no question about the profitability of any of those companies, but guidance could make an impact, as we've seen.

Meta and Alphabet are the top two most heavily weighted stocks in the Communication Services Select Sector SPDR Fund (NYSEARCA: XLC), which was down 5.13% the week ending October 27. Those two stocks drove communications stocks as a group lower.

Microsoft, Apple and Nvidia are among the top-weighted stocks in the Technology Select Sector SPDR Fund (NYSEARCA: XLK), which was down 1.17% the week ended October 27.

Higher yields could hurt techs

The tech sector is down 1.10% in the past month.

One factor that could result in a continued downturn is higher interest rates and Treasury yields, a result of Federal Reserve actions and concerns over the broader economy.

Technology and growth stocks are vulnerable to higher bond yields due to those stocks' long-term earnings potential.

When bond yields rise, fixed-income investments become more attractive, causing investors to sell high-valuation tech stocks in favor of bonds, where they can make more money.

Higher yields also increase borrowing costs for growth companies, impacting their profitability, which in turn causes stock prices to drop.

Are investors selling techs in favor of bonds?

In addition, growth and tech companies are more vulnerable to higher yields, as their typically robust projected future cash flows are valued less highly when investors can earn more from risk-free government bonds.

In other words, can a musty old asset class like bonds put growth and tech returns at risk? In this particular environment, it's a possibility.

The yield on the benchmark 10-year Treasury was 4.86% on October 27, the highest level since 2007.

Higher rates, while not yet demonstrably affecting consumer spending, may yet have that effect. Recently, Tesla CEO Elon Musk Tesla said he believed higher interest rates could put a damper on car buying.

Higher rates can hurt the broader economy by increasing the cost of borrowing for businesses and consumers, which can lead to reduced investments, spending, and economic growth. It's possible the pain could spread well beyond the Magnificent Stocks.

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Could 7 tech giants drag down the broader market?

Techs led the market lower in 2022

Fading EV boom drives Tesla lower

Higher yields could hurt techs

Are investors selling techs in favor of bonds?

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