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US outlook: Will small-caps close the gap with the large-caps in 2024?

21 December 2023

Trustnet’s collection of managers’ outlooks for the US market.

By Matteo Anelli,

Reporter, Trustnet

This year has been a great one for US stocks and consumers. The S&P 500 surprised many with its resilience, mainly attributable to the so-called ‘Magnificent Seven’ – Apple, Microsoft, Amazon, Alphabet, Facebook, Tesla and Nvidia – which at a combined 29% of the index’ market capitalisation, beat the pre-Covid 40-year high by a full five percentage points.

At the same time, the US consumer has been able to keep spending by dipping into its savings from the Covid era.

While there is consensus around the fact the latter trend has now played out, and people’s wallets are already starting to feel the pinch, opinions are much more varied around the fate of the seven tech darlings.


Rathbone’s Thomson: It is harder and harder to find companies with strong growth prospects

James Thomson, FE fundinfo Alpha Manager of the Rathbone Global Opportunities fund, kept his conviction in the magnificent seven, owning five of them.

“It is important to stick to areas where you have a track record of investment success,” he said. “For two decades since the fund's launch, I have looked for hidden industry champions. But it is harder and harder to find companies with strong growth prospects – and we have seen a narrow band of just seven stocks drive the S&P 500 performance.”

While the outlook remains “challenging”, a recession could create an inflection point next year where the US Federal Reserve is forced to act, according to the manager.

“For me, inflation is a more important economic factor than recession, and everywhere I see that coming down from logistics to commodities – even a Thanksgiving dinner was down 4.5%," he added.

“However, now is not the time for one-way bets and we need to own the companies that can survive in any economic cycle. We are in a different world, and it is important to have recession-resistant stocks.”

As examples, the manager gave Costco, whose price mark-up ceiling retains a loyal and growing client base, and Microsoft, which has recently embraced the artificial intelligence (AI) revolution. 


Aegon’s Haworth: The magnificent seven could continue to outperform

Phil Haworth, head of equities at Aegon Asset Management and manager of the Aegon UK Equity fund, sees a 2024 environment that is likely to provide a different set of challenges to that of the recent past. However, the outperformance of the magnificent seven could remain constant.

“The odds seem stacked against continued mega-caps leadership, but strategists have already had to re-write their assumptions,” he said. “The ‘magnificent seven may continue to perform well, especially Nvidia and Microsoft, which are driving the development of AI, but absolutely expect greater market breadth in 2024.”

From the macroeconomic picture, the manager expects more opportunities for alpha generation.

“Profit growth will be hard to come by and is certainly likely to disappoint the global consensus forecast of 10%. This suggests a stock picking focus upon quality, strength of balance sheet and profitability could be the winning strategy in 2024.”

Clearbridge’s Glasser: Performance divergence within the S&P 500 will reverse

Others are not so sure and believe that sectors other than tech will take a bigger share of the S&P 500’s returns, such as Scott Glasser, co-chief investment officer and manager of the Clearbridge US Appreciation fund, who thinks that the performance of the US market is “far more varied and nuanced” than one might assume by just looking at the S&P 500.

Large-cap growth strategies have surged this past year on the back of the magnificent seven, while all value and small-cap categories have trailed by approximately 30 percentage points. Furthermore, only three of 11 sectors in the S&P 500 are outperforming the overall index, a condition that has impacted the returns for most diversified strategies.

“We expect this divergence between the market-cap weighted and equal-weighted S&P 500 to reverse as other sectors of the market gain relative ground,” he said.

“While we do not expect the magnificent seven to decline materially, we also do not anticipate the same step higher in earnings for those companies as we saw in 2023. Instead, relative leadership could broaden and include more defensive-oriented groups, such as health care, that have been underperformers this past year.”


Federated Hermes’ Sherlock: We remain constructive on US small and mid-caps

Despite the fiscal, monetary and political uncertainties, Mark Sherlock, manager of the FE fundinfo five-Crown rated Federated Hermes US SMID Equity fund, remained “constructive” on US equities.

“Elections give clarity to investors and the period after an election has historically been positive for US equities,” he said, noting that since its inception, the Russell 2500 index has outperformed the S&P 500 in three of the past four first years post-election.

Small and mid-caps in particular should do well “regardless of who is sitting in the White House”, as the manager said recently.

“The softer inflation data supports the case that interest rates have peaked and provides scope for cuts next year if we see an economic slowdown. A robust domestic economy with structural tailwinds should be supportive for US small and mid-caps given that it trades demonstrably cheaper than large-cap versus its longer-term average.”

He concluded by saying that the tighter monetary policy will be supportive of quality companies with strong balance sheets, robust marketing positions and pricing power.


Redwheel’s Lance: The returns of growth stocks will be hit

On this side of the pond some experts are suggesting this could be the right time to cut down portfolio weightings to the US.

Ian Lance, manager of the Temple Bar investment trust, recently told Trustnet that allocating money to global indices is a mistake right now because around 70% of them are made up of US companies and the US stock market has “pretty much never been more expensive than it is today”.

“We believe that the focus of the industry should be to use this year’s rally in US technology stocks to rebalance from US equities (which look very expensive compared to history) and to look into other geographies such as UK, Japan and emerging markets, and from growth to value,” he said.

“The only way for governments to inflate away their enormous debt loads is to follow a policy of financial repression in which interest rates stay below inflation rates. This will lead to a regime change in which the stocks that performed well in the last decade do badly in the next decade and vice versa, suggesting that growth stocks will be hit as they de-rate whilst value stocks should be poised to do better.”

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Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.