Mega-cap stocks, led by the Magnificent Seven companies, continue to be at the forefront, whether it is a rally or a pullback, underlining their undue influence on the market. Against this backdrop, Morgan Stanley analysts led by Erik Woodring on Wednesday delved into the damage the sell-off has inflicted on the mega-cap space and the outlook for these stocks.

Valuation Not So Depressed? The Magnificent Seven valuations are now 30% off the trailing five-year peak but still 50% above the trailing five-year trough, said Morgan Stanley analysts in the note. "This compares to the NASDAQ 100 that is 20% off its T5Y valuation high and 37% above its T5Y valuation low, and the Russell 2000 that is 56% off its T5Y valuation highs but 50% above its T5Y valuation low," the analysts said.

The group comprises seven of the biggest mega-cap stocks, belonging to the IT and communication services sectors, as well as the electric-vehicle industry. The constituents are:

• Nvidia Corp. (NASDAQ:NVDA)
• Microsoft Corp. (NASDAQ:MSFT)
• Meta Platforms, Inc. (NASDAQ:META)
• Apple, Inc. (NASDAQ:AAPL)
• Alphabet, Inc. (NASDAQ:GOOGL) (NASDAQ:GOOG)
• Amazon, Inc. (NASDAQ:AMZN)
• Tesla, Inc. (NASDAQ:TSLA)

Attractive On Future Growth: While adjusting for future earnings per share growth, the group traded at a 40% discount to the trailing five-year price-earnings growth ratio, said Woodring. This, according to the analyst, is the critical distinction in a soft-landing scenario and supports the case for the Magnificent Seven stocks outperforming small-caps.

Following the recent stock market sell-off, the Magnificent Seven stocks were down 9% month-to-date through Aug. 5, on average, the analyst noted. This compared to the S&P 500's 6% decline and the Nasdaq's 8% decline, he said.

The analyst noted that Tesla and Nvidia were the relative underperformers in the group, flat for the month-to-date period.

"As a result, we'd conclude that while Mag 7 valuations still face significant downside valuation risk in a black swan or recession scenario, current Mag 7 valuations relative to future growth prospects are attractive after the recent drawdown," Morgan Stanley said.

The view comes amid expectations that the mega-cap momentum will moderate, potentially giving the lead to small-caps, as the Federal Reserve is widely expected to cut interest rates, beginning in September. Morgan Stanley's analysis suggests the Mag 7 rally may have further leg as long as the economy averts a recession or hard landing.

The Invesco QQQ Trust (NASDAQ:QQQ) climbed 0.64% to $450.94 in premarket trading Friday and the Roundhill Magnificent Seven ETF (NASDAQ:MAGS) rose 1.35% to $420.70, according to Benzinga Pro data. The iShares Russell 2000 ETF (NYSE:IWM) gained 0.72% to $208.38.

• Nvidia Leads Chip Stocks Higher After 3-Session Sell-Off: What's Going On?

Photo via Shutterstock