Is there a correction ahead for tech stocks?

Key Concepts

• S&P 500: Standard & Poor's 500 stock market index, representing 500 large U.S. companies.
• Market Caps: Market capitalization, the total value of a company's outstanding shares.
• MAG 7 (Magnificent Seven): A group of large, influential technology companies (e.g., Apple, Microsoft, Alphabet, Amazon, Nvidia, Meta, Tesla).
• AI Infrastructure: The hardware, software, and network components necessary to support Artificial Intelligence operations.
• Capex (Capital Expenditure): Funds used by a company to acquire, upgrade, and maintain physical assets.
• Value Sectors: Industries or companies considered undervalued by the market, often characterized by lower valuation multiples and higher dividend yields (e.g., healthcare, energy, industrials).
• Hyperscalers: Companies that provide large-scale cloud computing services.
• Agentic Large Language Model: An advanced form of Large Language Model capable of autonomous action and decision-making.
• Valuation Multiple: A ratio used to value a company, commonly the price-to-earnings (P/E) ratio.
• Gross Margins: The percentage of revenue remaining after subtracting the cost of goods sold.
• Broadening Out: A market trend where gains are distributed across a wider range of stocks and sectors, rather than being concentrated in a few large companies.
• Cyclical Stocks: Stocks whose performance is closely tied to the overall economic cycle.
• Big Beautiful Bill: Refers to significant legislative packages providing tax benefits or incentives, likely related to infrastructure or clean energy.
• Forward P/E: Price-to-earnings ratio based on estimated future earnings.
• Tip of the Sword: A metaphor indicating being at the forefront or leading edge of a particular trend or industry.

Shifting Market Dynamics and Tech Weakness

After several years of tech giants dominating the S&P 500 with ever-increasing market caps, a new dynamic has emerged this year. The weight of the top 10 stocks in the S&P 500, primarily composed of the MAG 7 tech giants, has recently shown major weakness relative to the rest of the stock market. This trend is highlighted by a chart from RBC Capital Markets' Lori Calvacina.

Sentiment on tech has "soured" due to escalating fears of overspending on AI infrastructure. Many tech companies reporting earnings this week are expected to hike their capex plans, a move anticipated to be "much to the dismay of investors." Specific concern was raised regarding Meta's upcoming statements on this front. Consequently, investors have rotated out of tech and into more traditional value sectors such as healthcare, energy, and industrials, driven by these spending anxieties.

The Health of the MAG 7 and Market Rationalization

Art Hogan noted that this shift represents a "more rational market." While acknowledging the undeniable importance of the MAG 7, he suggested that their upcoming quarters are still expected to be "huge from top and bottom line perspectives," with the possible exception of Tesla.

Anz further elaborated on the market's health, observing that the MAG 7, after significant moves over a three-year stack, have "consolidated nicely." Specifically, Nvidia is "basically where it was when it reported earnings last quarter," and the rest of the group, excluding Alphabet (which has been the top performer), has "really moved sideways." This consolidation is viewed as "very healthy."

Despite concerns about hyperscalers needing to spend more to achieve the "agentic large language model dream," Anz argued that the MAG 7 (excluding Tesla) remain attractive. These companies are trading at an average 30 times multiple while typically growing their earnings between 40% and 60% and boasting gross margins "north of 60 to 70%." This combination of strong fundamentals and recent consolidation makes the group "much more attractive as we head into earnings."

The Broadening Out of Investor Focus

A significant trend this year, described as the "second story" after precious metals, is the "broadening out of investors." This means investors are looking "beyond these 10 large companies," which include entities like Berkshire Hathaway and Broadcom, and exploring the "490 other stocks to buy in the S&P 500." This diversification is considered a "healthy" development, a sentiment echoed by strategists who had anticipated this broadening out.

Supporting evidence for this trend includes year-to-date performance, where energy stocks are the biggest gainers, with materials and industrials also showing higher returns. This shift is partly attributed to the "big beautiful bill tax benefits tax incentives," which are driving some of these more cyclical stocks by offering tremendous savings and supporting infrastructure development.

Nvidia's Pivotal Role and Future Outlook

Regarding Nvidia, Art Hogan positioned its upcoming mid-February earnings report as the "earnings Pro Bowl" following the "earnings Super Bowl" of the current season. He highlighted that Nvidia is currently the "cheapest [it's] been for about 3 years," trading at 25 times forward earnings. This forward multiple is expected to "go down after the report because they're going to raise their guidance."

Nvidia is seen as the "tip of the sword for artificial intelligence spend," and its continued strong performance is expected to "reinvigorate the trade." Hogan agreed with Anz that the "broadening out" puts the market in a "much healthier place," but also noted that the consolidation in the "Big 10" (top S&P 500 stocks) makes them "a whole lot more attractive in real terms."

Conclusion

The market is undergoing a significant rebalancing, moving away from an over-reliance on a few dominant tech giants towards a broader and healthier distribution of investment across various sectors. While fears surrounding AI infrastructure spending have prompted a rotation out of tech into value sectors, the "Magnificent Seven" have experienced a beneficial consolidation, making their strong growth and high margins more appealing at current valuations. Nvidia, as a key driver of AI innovation, is poised to continue its strong performance, further energizing the AI investment landscape. This "broadening out" trend, supported by legislative tax incentives, signifies a more rational and diversified market environment.