"Magnificent 7" play key role in share market returns as investors eye benefits of AI

Overview of investment markets for the year ended 31 March 2024 from our investment manager, Mercer.

Over the past several years, global financial markets have been shaped by various themes such as the COVID-19 pandemic, geopolitical tensions and aggressive monetary policy set by central banks as they attempt to contain inflation.

Global shares delivered strong returns in the first half of 2023 with the advance led by a narrow cohort of US technology-based companies. Optimism around Artificial Intelligence (‘AI’) developments played a large part, as investors flooded into companies which are expected to benefit from the introduction of generative AI. This optimism around AI was centred around the “Magnificent 7”, a subset of large US mega-cap technology stocks comprising of Nvidia, Alphabet, Amazon, Apple, Meta, Microsoft, and Tesla. Nvidia, whose high-end processing chips are used to power AI applications like ChatGPT, led the Magnificent 7 as it saw soaring demand for its processing chips. Other prominent catalysts were moderating inflation and the continued strength of the US economy despite higher interest rates. As a result of high interest rates, government bond yields generally rose driving negative returns for fixed income and other interest rate sensitive asset classes.

The third quarter of 2023 saw US markets underperform as value stocks outperformed growth, and a retreat by the Magnificent 7, which had provided the majority of the gains during the first half of the year. The negative market sentiment was driven by a narrative of “higher-for-longer” rates as central banks around the world continued to communicate concerns of elevated inflation and opted for smaller-than-usual rate hikes or chose to leave rates unchanged all together.

Pessimism towards China’s economic recovery resulted in Emerging Market equities volatility. Although targeted economic stimulus was provided to the Chinese property sector early on, the announcement provided only temporary relief. Fears began to build that this targeted stimulus wouldn’t be sufficient to manage the debt crisis overwhelming several major Chinese property developers. Consequently, China's economic performance fell short of expectations as various indicators continued to signal a lacklustre recovery.

The downturn in performance faded as the year ended with equity markets rallying back towards their 2023 highs, and November providing the strongest set of monthly returns in over three years. With market commentators pronouncing the rate hiking cycle to be at its end and rhetoric from the US Federal Reserve (Fed) striking a dovish tone, investors reacted with enthusiasm at the prospect of rate cuts in 2024. This expectation of imminent rate cuts rapidly fed through to global bond markets, with yields falling across the curve in response.

The new year began with the hope of rate cuts in the near term, however such hopes were ultimately dampened as annual inflation figures came in higher than expected for the US, Eurozone and the UK. This resulted in most major global central banks electing to maintain rates at current levels. Despite this cloudy macro-environment, equities experienced robust gains across all major indices. Technology stocks once again leading the charge, buoyed by a resilient US economy and positive company earnings reports. Global fixed income markets were generally weak as the initial expectations of lower interest rates were scaled back to later in the year. 

Geopolitical risks remained at the forefront as conflicts in Gaza and Ukraine persisted and missile attacks in December caused temporary disruptions to shipping in the Red Sea. Although the initial market effects were relatively minor, there is a looming risk of escalation that could have significant implications for global supply chains, capital flows and commodity markets.

Key themes

• Stock markets rallied 24.4% in 2023, with technology stocks and growth stocks leading the way.
• Despite initial fears of a recession, the US economy remained solid, and inflation cooled.
• The Fed raised interest rates four times in 2023 but signalled that no additional rate hikes are expected, and rates will likely be lowered in 2024.
• As has been the theme for the past two years, the Fed’s monetary policy decisions and accompanying talking points have dominated market sentiment.
• Bond investors avoided a third straight year of losses, thanks to the big rally and drop in bond yields in the fourth quarter of 2023.
• Technology and growth stocks were the top performers in 2023, while value funds lagged.
• Growth-oriented stocks bounced back from the prior year’s losses (while value funds underperformed).
• Investors are positioning themselves for potential rate cuts in 2024.
• US financial system recovered (from the SVB and Credit Suisse banking crisis).
• China's economic performance fell short of expectations as various indicators continued to signal a lacklustre recovery.
• Geopolitical risks have increased and remain on the forefront as tensions increase.