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Magnificent Seven: what other sectors can you find value in?

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By Natixis IM

While the markets only have eyes for the Magnificent Seven, what other sectors can investors hope to find value in? We spoke to Danny Nicholas, Client Portfolio Manager at Harris Associates.

Why should investors be exposed to value investing when growth stocks have largely outperformed in recent years?

It’s true that growth has generated returns well in excess of value in the decade leading up to 2022, as we can see from the graph below. However, if we look at the longer term, it’s clear that performance has been much more mixed.

Ratio of total returns of the Russell 1000 Growth index to the Russell 1000 Value index
Why should investors have value investing exposure when growth has outperformed so strongly in recent years? It's true that growth significantly outperformed value for the decade prior to 2022, as you can see in the chart below, but if you look longer term, performance has been much more mixed.
Source: Harris Associates USD analysis based on FactSet data from October 31, 1992 to March 31, 2024. Actual performance may be lower or higher than the performance data used. All returns reflect reinvestment of dividends and capital gains after deduction of transaction costs.

Since 2022, both growth and value have dominated at different times, trends that have historically followed one another. Growth outperformed value in the late 1990s, then value outperformed growth from 2000 to 2006. At present, we’re approaching peak levels of growth versus value performance. At this level, we believe there is reason to consider a longer period of outperforming value.

In 2024, the S&P 500 index reached all-time highs on more than one occasion. Against this backdrop, is the North American market currently more attractive in terms of investment?

It’s not unusual for the S&P 500 to reach a new all-time high. Over the past five years, it has hit a new all-time high 165 times, an average of almost three times a month.1 Experienced investors know that it’s very difficult to predict market trends, and that for both fundamental and value stock pickers, any time can be a good time to invest, the key being to choose the right stocks at the right time. While it’s true that the S&P 500 is trading at a relatively high valuation today, what makes it attractive to us is that there’s a wider-than-usual spread between stocks with high price/earnings (P/E) ratios and those with low P/E ratios. This gives stock pickers more opportunities to outperform the benchmark. Today, we can create a well-diversified portfolio with an average P/E ratio of around 10x (compared to a P/E ratio of 27x for the S&P 500 and 19x for the Russell 1000 Value Index).2

All the attention has been focused on the “Magnificent Seven” and AI companies. Do you see this as an opportunity?

Artificial intelligence is an incredible development that will undoubtedly change our lives, but that doesn’t mean all AI companies will emerge winners. Many well-known AI companies are currently very highly valued, and for value investors like us, the risk/reward profiles are far from favorable.

The recent strong performance of the Magnificent Seven has increased technology concentration in the S&P 500 index, and even more so in the Russell 1000 Growth index. Today, we’re finding better opportunities in stocks that harness AI more indirectly. For example, Capital One Financial (NYSE:COF) excels in using consumer data to issue bank cards, and has always been more advanced in its use of technology than its competitors. Capital One’s management team has made it clear that it is counting on AI to reinforce its technological advantage by lowering costs and improving customer satisfaction.

In recent months, we’ve seen the recovery spread to other sectors in addition to AI innovators. If this movement continues, value investors should be well positioned.

Value investing is often a matter of patience. How do you manage to stay disciplined and avoid the so-called “value traps”?

The key for us is to remain true to our philosophy and the processes we have developed over many years. One of our three investment principles, “companies whose value per share is expected to grow at least as fast as the S&P 500 over time”, is designed to help us avoid these value traps. We also employ the “devil’s advocate technique”, in which an analyst who doesn’t cover the stock presents his or her case against an investment. This consistency of approach has been at the heart of our funds’ performance since our inception in 1976, and has also earned us the award for Best Value Equity Fund Provider, as well as the jury’s congratulations in the US Equity category of the 2024 Asian Private Banker Asset Management Awards for Excellence3.

Harris Associates is an affiliate of Natixis Investment Managers.