If you’re an investor who’s reaped huge returns from the Magnificent Seven, you might be asking: Is now the time to exit? Rob Arnott thinks the answer is yes. Arnott is founder and chairman of Research Affiliates, which oversees strategies for nearly $200 billion in index funds and ETFs for firms including Charles Schwab and Invesco. Overall, his forecast for the market was grim: He warned that shareholders of U.S. large-cap stocks would see one-fifth of the returns since 2016 over the next decade, and those meager gains would barely affect the Consumer Price Index (CPI).
But he predicts a unique world of harm for big U.S. tech investors. When he dug into the difference in outlook between the S&P’s value and growth factors, he discovered a huge chasm. The RA model predicts an annual return of 4% for the former, and a staggering 1.4% for the latter, meaning that the returns for recent champions will be behind Inflation is one percent. He said a lot of the headwinds come from valuations that are too high, and it’s going to be hard for them to grow from here on top of being so profitable. He acknowledged that one of the main reasons we saw double-digit earnings per share growth was “the amazing growth of Mag 7.” Now, he adds, “Growth stocks are trading at very rich valuations, driven by Mag 7. The market believes it’s a foregone conclusion that their earnings will grow wildly. But in order to beat the market, they need to grow earnings faster than those lofty expectations.”
Arnott is particularly skeptical of the premiums offered by investors expecting huge profits from artificial intelligence. “The companies making money from AI are the ones selling the tools,” he said. “They are now offering loans to their own customers so that those customers can keep buying their stuff. And their customers are having a hard time monetizing the devices.” said Arnott, who just used Perplexity to do a deep dive into how various proposed tax increases would affect marginal tax rates at different income levels, and paid nothing for the service. “These AI providers are going to figure out how to make money,” he said. “But not as fast as its share price expected. It’s going to be a slow growth process over the long term, which means the returns on these stocks will be much lower than the market’s returns.”
Here’s his advice: “If you have a Mag 7, say ‘Thank you very much, Mag 7,’ get off and don’t ride them back.” Arnott believes returns outside the U.S. will be much higher than within the U.S. For example, RA believes that developed, non-U.S. value stocks will provide a return of 7.4% going forward, more than double the S&P 500’s forecast, and that emerging market value stocks will perform even better, at 7.6%. Arnott concluded that the best strategy is “first, not to own any U.S. stocks or at least reduce your position, and second, not to own any growth stocks.”
This story originally appeared on Fortune.com
