Magnificent 7’s dominance creates greater opportunities for value investors

With all eyes on the Magnificent Seven, where else can investors look to unearth value? We sat down with Harris Associates' Client Portfolio Mananger, Danny Nicholas, to get his thoughts.

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 analysis in USD using FactSet data from October 31, 1992 through March 31, 2024. Current performance may be lower or higher than the performance data quoted. All returns reflect the reinvestment of dividends and capital gains and the deduction of transaction costs. 

Since 2022, growth and value have both outperformed at various times and this has also been the case through much of history. Growth outperformed value in the late 1990s and then value outperformed growth from 2000 – 2006. Right now, we are almost at peak levels of growth’s performance relative to value. At these levels, we think there is a case to be made for a more sustained period of value outperformance.

In 2024, the S&P 500 Index has reached all-time highs several times. Given this, is the U.S. market currently an attractive place to invest?

It’s not unusual for the S&P 500 to achieve a new high. Over the past 5 years it reached a new high 165 times, that’s nearly three times a month on average¹. Experienced investors know that timing the market is very difficult and for fundamental stock pickers and value investors any time can be a good time to invest – the key is picking the right stocks at the right time. While it’s true that the S&P 500 is trading at relatively high valuation today, what makes it look attractive to us is that that there is a wider spread than normal between high price to earnings (P/E) stocks and low P/E stocks. This creates greater opportunities for stock pickers to outperform the index. Today, we can put together a well-diversified portfolio at an average P/E of around 10x (compared to a P/E ratio of 27x for the S&P 500 and 19x for the Russell 1000 Value Index²).

All the focus has been on the ‘Magnificent 7’ and AI companies. Does this present an opportunity do you think?

AI is an incredible development which will undoubtedly change all our lives, but that doesn’t mean all AI companies will be winners. Many well-known AI companies are currently very highly priced and for value investors like us, the risk/reward profiles just don’t stack up. 

The strong recent performance of the Magnificent 7 has increased the technology concentration in the S&P 500 Index and even more in the Russell 1000 Growth Index. We are currently finding greater opportunity in stocks are employing AI more indirectly. For example, Capital One Financial (NYSE:COF) excels at using consumer data to issue cards and has consistently been more advanced in its use of technology than competitors. Capital One’s management has explicitly stated they expect AI to help it increase this technological edge by lowering costs and improving customer outcomes.

We have seen in recent months that the rally has broadened out beyond the AI inventors into other sectors; if this continues then investors with an allocation to value should be well positioned.   

Value investing is so often about patience. How do you stay disciplined and avoid so-called value traps?

The key for us is to stick to our investment philosophy and the processes we have developed over many years. One of our three investment tenets “companies expected to grow per share value over time at least as fast as the S&P 500” is designed to help us avoid value traps and we also use ‘Devil’s Advocate Reviews’, in which an analyst not covering the stock presents the “bear case” against an investment. This consistency of approach has been the key to our funds’ performance since we were founded in 1976 and also critical to us winning “Best Fund Provider Value Equity” and “Highly Commended - US Equity” in the 2024 Asian Private Banker Asset Management Awards for Excellence³.

Harris Associates is an affiliate of Natixis Investment Managers.