Rising risks as the S&P 500 is outsourced to ‘the Magnificent Seven’

Guest Author

Billy Gridley

As different measures of temperature smash records every day and month, the U.S. stock market also is surging to record highs. The bull market has been fueled by the American tech powerhouses known as ‘The Magnificent Seven.’

The nickname conjures the heroes of the 1960 Hollywood classic, tough guys who rescue Mexican villagers from bad bandits. The original Seven (Yul Brunner, Steve McQueen, and Charles Bronson among others) were strong, powerful, do-good gunslinger bros.

Today’s Seven – Apple, Amazon, Meta, Microsoft, Alphabet, NVIDIA and Tesla – are crushing their competition, churning out gobs of cash and driving the stock market skyward. An expansion of the so-called FANG stocks of several years ago, the Mag Seven, as they’re called, are together worth $13 trillion, or roughly 29% of the value of the S&P 500. Their combined market value is equal to that of the next 40 or so companies in the index and their rising share prices accounted for nearly all of the index’s 26.5% in gains in the last year. Last week, the elite group pushed the S&P 500 over 5,000 for the first time, on the back of earnings blowouts and earnings-multiple expansion. 

The Magnificent 7 are making people rich, while laying off workers. These same companies  are leading the headlong charge into an AI future – while facing congressional hearings, antitrust inquiries and civil lawsuits. 

What’s good for the Mag Seven may not be good for other companies, or for society at large. The tech giants are leaders in large markets with little competition – search, software, social media, ecommerce, advanced chips and electric vehicles. They are global, profitable and powerful. They are American. They are the dominators or, dare I say, the terminators.

Their dominance comes with negative externalities that go beyond mere market concentration. Some of their business models (looking at you, Meta) contribute to the spread of disinformation, political manipulation, invasion of privacy, cyberbullying, scamming, and a mental health crisis, especially among youth. Their headlong embrace of AI could exacerbate those issues. 

Split screen

Not all shareholders are happy. A growing school of diversified investors with long-term horizons are concerned about the effects that individual companies have on their broader portfolios. Until recently, most investors have largely ignored such “systemic beta” – the effect on their portfolios of the health of economic, social and ecological systems, as a whole. Such investors are attempting to mitigate the risks a single stock – in this case seven stocks – have on their portfolios as a whole.

False information spread on Facebook, intended to mislead users on climate change, racial justice and other issues, may drive ratings and clicks, for example, while destroying lives and trillions of dollars in economic value. 

“We are greatly concerned that a narrow, company-only view of shareholder primacy fails most shareholders, is inconsistent with modern investing practices, and threatens markets’ utility to allocate resources,” Rick Alexander of Shareholder Commons wrote in a recent update on a lawsuit against Meta. “It poses increasing danger to the systems that support not only investors, but our entire economy.”

A shareholder proposal filed by As You Sow asks Meta to assess the benefits of banning political ads. 

The split screen is striking, with last month’s Senate Judiciary committee hearing fresh in our memory even as recent BigTech headlines were dominated by the roaring but narrow stock market. 

Microsoft soared above $3 trillion in market capitalization. As CEO Satya Nadella said, “We have moved from talking about AI to applying AI at scale.” Amazon delighted with earnings some 24% above estimates. 

Meta’s operating profits tripled and the stock soared 20% on the initiation of a dividend. Now worth a cool $28 billion, founder and CEO Mark Zuckerberg is wooing income-oriented investors. “We had a good quarter as our community and business continue to grow,” he said matter-of-factly. “We’ve made a lot of progress on our vision for advancing AI and the metaverse.”

That’s a sunnier message than the one Zuckerberg heard at the painful Senate hearings on online child exploitation via social media. “You have blood on your hands,” South Carolina’s Sen. Lindsey Graham dramatically lectured Zuckerberg. 

The Meta CEO apologized to deeply harmed families, some of whose children had committed suicide. 

“Algorithms used by the platforms have been “designed deliberately to addict young minds and prey on teenagers’ well-understood vulnerabilities,” a Nevada official said as the state joined 42 other states in legal action against Meta. 

Multiple lawsuits have been filed against the company, including one by state Rep. Brandon Guffey of South Carolina. He is suing Meta for wrongful death and gross negligence after his son committed suicide in the wake of sexual exploitation on Instagram. A mourning Guffrey received a private instagram message with a smiley face emoji from his son’s tormentor. 

Negative externalities

Meta makes a good example for the broader case to consider the social and systemic risks of the seven technology samurai. The $1.2 trillion market-cap company dominates social media via Facebook, Instagram, and WhatsApp. It announced that its monthly active user base is now 4 billion people. 

AI + social media + internet = power. The complex and fraught set of interrelated subjects are about more than just fake news and poor mental health. It is about privacy, wealth, employment, democracy, life and more. It is about the technologies, companies and systems which increasingly define the contour of our lives. 

Legislation and other efforts, some bipartisan, would reform laws for on-line social media content monitoring and associated company liability. The woefully outdated Section 230 of the Communications Decency Act of 1996 protects online services from liability both when they do and do not moderate third-party content. Meta has been brazen in its efforts to oppose repeal or reform of Section 230.

The Federal Trade Commission has opened AI antitrust inquiries into Alphabet, Amazon, and Microsoft, a major investor in Sam Altman’s OpenAI. Meta, meanwhile, faces a new FTC antitrust lawsuit over its acquisitions of Instagram and WhatsApp and dominance in social media apps.

Meta’s wide-ranging negative externalities are the focus of a high-profile class action lawsuit in Delaware court alleging that the Meta board of directors breached their fiduciary duties by ignoring the impact of company operations on diversified shareholders. The lawsuit, McRitchie v Zuckerberg, states: “The directors and officers of the Company cannot willfully blind themselves to this reality: where there is great power there is great responsibility.”

Specifically, the suit claims Meta’s directors “must consider the company’s impact on the economically important systems that support its shareholders’ diversified portfolios,” according to a summary from Shareholder Commons. James McRitchie is the editor of Corporate Governance and a longtime proponent of shareholder proposals. 

Meta directors have a duty to consider broader harm and externalities, weighing not only the interests of a company but the broader interests of its own diversified shareholders. Consider it a “portfolio theory” of corporate governance that considers financially material externalities. The suit focuses on externalized costs which then get reinternalized in diversified portfolios.

The court’s decision, due next month, is likely to be appealed to the Supreme Court. Whichever way it goes, it will be significant for all companies in determining the breadth of shareholder interests that company directors must consider.

Arguments rely upon modern portfolio theory, or MPT, still the dominant paradigm for today’s investors. In 1952, Harry Moskowitz suggested that investors should use a diversified portfolio approach in order to maximize return, given a preferred amount of total risk. Diverse portfolios allow investors to reap the increased returns from risky securities while significantly reducing their overall risk profile.

The essence of MPT: do not put all your eggs in one basket. Rather, spread your risk over multiple diverse baskets. The essence of McRitchie: directors must consider not just the Meta ‘basket’ of operations, but the impact of that basket on all the other baskets that its stockholders might be carrying.

The thesis is not dissimilar to the market failure that drives climate change, namely the externalization of the costs of carbon and greenhouse gas pollution. Because there is no consequence for emissions, the ultimate impact and cost of the pollution is borne by all of humanity, all stakeholders.

Tragedies can quickly arise when externalities are imposed on others.

Meta’s attorneys asked for the lawsuit to be dismissed with prejudice. McRitchie is suing Meta as a test case, they charge, to “share his theories on how he thinks corporations should operate.”

Overlords

Already, I have no practical choice as an individual but to pay my monthly subscriptions to Apple, Microsoft, and Google. I do own a Chevy Volt, not a Tesla (because I cannot stomach certain people). I do not use Facebook because I think it is silly. I am trying to break my Amazon habit in favor of local or regional sellers. I may have a NVIDIA chip in one of many devices. 

Will the dominance of the Magnificent Seven extend increasingly to all and more aspects of our lives? These nifty companies generate enormous cash flows, and their combined $13 trillion valuation reflect investor beliefs that these exceptional money-spinning capabilities will continue unimpeded well into the future as the AI revolution kicks into successively higher gears.

Will they continue rising, unimpeded by antitrust enforcement or social rejection, until they represent 40% or 50% of the S&P 500?

This narrow Magnificent Seven stock market rally is reminiscent of, but even narrower than, the “Nifty 50” mania of the early 1970s where “one-decision” stocks, like Coca-Cola, Kodak, IBM, Polaroid, and Xerox typified the “new economy” of seemingly endless possibility. Fewer and fewer stocks drove the major stock market indices higher until a peak in December 1972. It was followed by a vicious, straight-line 50% drop in the bear market of 1973-1974. A bubble of irrational stock market optimism burst.

Today, optimism is high that a host of advanced and AI technologies will be developed, improved, harnessed, and directed to mitigating, avoiding, and adapting to climate change, among other challenges. (Nevermind that AI itself requires vast quantities of electricity). Leading the charge are the Magnificent Seven, perhaps minus Tesla.

“By applying AI to meet the greatest existential threat facing humanity,” ImpactAlpha wrote recently, “AI can perhaps be absolved of itself being the greatest existential threat to humanity.”

Sticks and satellites

What perhaps distinguishes humans from others in the animal kingdom is our extraordinary ability to develop technologies, to make tools and harness nature, to galvanize iron with the energy of coal, build ships, loft weapons of mass destruction and satellites into the sky, apply data and discover and synthesize vaccines. Technology has dramatically helped provide a rising standard of living for the masses of humans.

According to a rather Panglossian worldview, the polycrisis and climate change will be met and solved by technology. The underlying argument: we already have a panoply of silver bullets; we must simply apply this technology at scale: if it gets a bit bumpy, we will just invent new climate solutions. This is what is known as “techno-optimism.”

We are accelerating in a “faster, cheaper, better” world. In Silicon Valley, this “better” is also “cooler,” which may be welcome when it comes to solving global warming.

Yet, is it too much to ask that – as Alphabet’s Sergey Brin and Larry Page once decreed – that technology companies do no evil? “We believe strongly that in the long term, we will be better served—as shareholders and in all other ways—by a company that does good things for the world even if we forgo some short term gains,” the pair wrote in the search company’s 2004 IPO prospectus.

It is not doomerism to examine and discuss what really is “better,” and for whom. 

Which shareholders, constituencies, communities, and stakeholders benefit within what rules of the system? Which financially material environmental and social externalities are being accounted for on our evolving ledgers of value? 

Better is about the health of the larger systems in which we live. Better is about rules of the game with adequate guardrails to steer us toward optimal outcomes for all. 

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Billy Gridley is Managing Member of Benedict Partners, a sustainable investment consultant.