"Seven giants" rare negative correlation with S&P 500, opportunity for recovery brewing in tech stocks decline?

During this three-year bull market, the S&P 500 index has been closely following the stock prices of tech giants for most of the time. However, this close correlation between the two is suddenly breaking down - which may be a good thing for struggling tech stocks. The correlation between the index tracking the "Magnificent Seven" and the equally weighted S&P 500 index (which accurately reflects the overall performance of all stocks by excluding the weights of the largest companies) turned negative on February 23, indicating that their trends are no longer synchronized. Since then, with the disruption caused by the Iran war in the market and the resulting surge in oil prices, this negative correlation has continued to deepen. "We have never experienced a tech cycle changing so quickly," said Daniel Newman, CEO of Futurum Group. "We cannot predict what will happen next." Since the beginning of 2016, the current negative correlation level has only occurred once. In the first quarter of 2023, with the artificial intelligence frenzy sparked by OpenAI's release of ChatGPT on November 30, 2022, the "Magnificent Seven" - including Nvidia, Apple, Microsoft, Google parent company Alphabet, Amazon, Meta Platforms, and Tesla - surged ahead. Meanwhile, other stocks in the S&P 500 index remained subdued as they struggled to break out of the bear market. From January to March 2023, the "Magnificent Seven" index rose by 45%, while the traditional S&P 500 index only increased by 7%. Ultimately, the enthusiasm for tech stocks spread to the entire market, with the S&P 500 index rising by 24% in 2023 and another 23% in 2024. Prior to the breakdown of this correlation, the "Magnificent Seven" had lagged behind the broader market for several months due to concerns about massive AI spending. From the end of October last year to February this year, Bloomberg's "Magnificent Seven" index fell by 7.3%, while the equally weighted S&P 500 index, led by cyclical sectors such as energy and materials, rose by 8.9% during the same period. In the weeks following the negative correlation, the trends of the two major indices switched positions. Although the "Magnificent Seven" has entered a correction zone this month, its decline is still less than the broader market benchmark. Change in the air Of course, the current market situation is vastly different from three years ago, with the cloud of the Iran war hanging over everything. At the same time, the performance of the "Magnificent Seven" is also weighed down by pre-existing concerns about the massive investments in AI and the disruptive impact this emerging technology will bring. "A few years ago, when the correlation of the 'Magnificent Seven' was higher, Nvidia continuously delivered better-than-expected earnings revisions," said Jonathan Kovinsky, portfolio manager at Junli Henderson Investment. "Back then, we weren't as concerned about capital spending and return on investment, nor did we have as much concern about AI and software, and Apple didn't face memory shortages." The last time the correlation was at such a negative level marked the beginning of a significant period of outperformance for the "Magnificent Seven". From early 2023 to February 23 this year, the "Magnificent Seven" index surged by over 300%, while the equally weighted S&P 500 index only increased by 42%, and the traditional S&P 500 index rose by 78%. While few on Wall Street expect history to repeat itself, there is reason to be optimistic about the "Magnificent Seven" regaining market leadership. Esan Kwan, chief stock strategist at Fulcrum Bank, said that the recent pullback in these stocks has cleared out overextended positions and pushed valuations to attractive levels, setting the stage for outperformance in the future. "We are seeing one of the most extreme relative outflows from the US stock market to international markets," Kwan pointed out, attributing this reversal to the tariff plan introduced by the Trump administration in April last year. "This was a crowded trade before, and with this war erupting, the situation is starting to reverse. And the most obvious beneficiaries will be the technology sector, especially large tech stocks." Market aggregation data shows that the expected price-earnings ratio of the "Magnificent Seven" index is currently less than 25 times, lower than the nearly 33 times in October last year, and below its ten-year average of 29 times. This is the lowest level since the "tariff panic" in April last year. Considering that these seven companies account for about one-third of the market capitalization-weighted of the S&P 500 index, the recovery of tech giants will be a major positive factor for the overall market. "We are approaching a point where large-cap tech stocks are becoming irresistible," said Newman of Futurum. "In this environment, if you invest here, you can sleep peacefully at night. They are so enduring, resilient, and have consistently outperformed for several quarters in a row." Nvidia's stagnation However, there is a major issue for the bulls: Nvidia. As the world's largest market cap company - and therefore the largest constituent in the S&P 500 index - its upward momentum has stalled. After surging over 1100% from the end of 2022 to July last year, the stock has been consolidating sideways for the past seven months as the market worries that its rapid growth is nearing its peak, and investors are becoming weary of the massive AI spending by its largest customers. These doubts were evident last week when Nvidia CEO Huang Renxun predicted that data center sales would reach $1 trillion by 2027, but this forecast did not boost investor sentiment. Despite many other positive news announced at its annual developer conference, including gaining approval from the Chinese government to resume AI chip sales in China, the stock closed down 4.1% that week. "The market is telling you that earnings expectations are too high," said Randy Haal, portfolio manager at Huntington National Bank, holding Nvidia stock. "We don't agree with that, so we think the stock is relatively attractive." Another obstacle faced by the "Magnificent Seven" is the deterioration of free cash flow as these companies compete to build AI computing infrastructure. The largest spenders - Amazon, Microsoft, Alphabet, and Meta - are expected to have a combined free cash flow of $94 billion this year, significantly lower than $205 billion in 2025 and $230 billion in 2024. Michael O'Rourke, chief market strategist at Jonestrading, believes that while the valuations of large-cap AI stocks have declined, the market still has doubts about data center spending and the depreciating assets on the balance sheets of these companies, which remains a major issue. "The business model of mega-cap companies has changed, so they should receive lower valuations," O'Rourke said. "The 30% valuation gap between the S&P 500 index and the equally weighted S&P index is fully worth turning to the equally weighted index for investors who hope to navigate volatility smoothly." Nevertheless, the earnings growth of the "Magnificent Seven" remains strong. According to the data compiled, their profits for 2026 are expected to increase by 19%, while the profits of the other 493 companies in the S&P 500 index are forecasted to grow by 14%. Newman of Futurum Group believes that the ability to generate profits above other parts of the market is ultimately what investors value most. "These companies have performed admirably," said Newman of Futurum Group. "Looking at the results they deliver, it's hard not to ask: why would you want to invest elsewhere?"