China turmoil poses a risk to the Magnificent 7, Jeremy Grantham's GMO says

• Stock market gains are highly concentrated among the so-called Magnificent Seven stocks.
• That's a risk in itself, but investors should be aware the group is uniquely exposed to China risks, GMO says.

Investors reveling in the stock market boom that's been aided in large part by the Magnificent Seven may be undercounting the risk of geopolitical conflict in China.

In a letter to investors this week, GMO, co-founded by legendary market veteran Jeremy Grantham, said that a disruptive geopolitical event in China is a "common risk" for all stocks in the Magnificent Seven — Apple, Amazon, Nvidia, Tesla, Meta Platforms, Alphabet, and Microsoft.

The big risk in such an event would be reduced access to China and Taiwan's chip industries, which these firms rely on heavily for continued development of the technologies that have generated so much excitement among investors, namely artificial intelligence.

"A geopolitical event that hurts U.S. companies' access to China, Taiwan, and the semiconductor industry would therefore be profoundly uncomfortable for this group of companies," GMOs' Ben Inker and John Pease wrote in the letter.

On top of risks to semiconductor supplies, the group of mega-cap stocks has an average revenue exposure of close to 20% to China and Taiwan, GMO noted, and four of them have relationships with Taiwanese manufacturing giant Foxconn.

Expanding investment in AI by the seven market-cap leaders has heightened their reliance on Taiwan, which is the world's leading chip supplier. The development has sparked concerns on Wall Street about the potential impact of a move by China to take over Taiwan.

"Investors who are averse to the 4% combined weight of China and Taiwan in MSCI ACWI should be mindful of the 17% combined weight of the U.S. superstars in that same index," GMO wrote.

As Taiwan just wrapped up its 2024 election, it must navigate preserving its current status quo while maintaining some degree of autonomy amid escalating Chinese military actions and rhetoric, heightening investors' worries over escalating tensions.

Stepping back, the world's two biggest economies have seen contrasting trends in their stock markets. The US equity market has surged thanks to stellar quarterly GDP growth, a rebounding labor market, and rapid advancements in AI.

The surge so far this year has culminated in the S&P 500 breaching the 5,000 mark this week for the first time ever.

On the flip side, China is making significant efforts to rescue the stock market from a severe downturn worsened by a property crisis, deflationary pressures, and demographic headwinds. The country has introduced economic stimulus packages, including crackdowns on short-selling and insider trading, but investors' confidence in stocks still remains low.

The Magnificent Seven mega-cap tech stocks now make up a massive 29% of the S&P 500, raising alarms about the sustainability of the latest market rally. Yet, BMO chief investment strategist Brian Belski said this week that extreme concentration in the stock market is an overstated risk and shouldn't stop investors from buying stocks.