What to do with US mega caps is one of the main preoccupations for many investors today, who worry whether their exceptional performance over the past 18 months can continue going forward.
Even for investors who believe in the AI narrative, it would now be prudent to take profits and explore other markets, according to Hugh Gimber, global market strategist at JPMorgan Asset Management. That's especially true for passive investors.
“Within the US, investors who have been sat passively are seeing portfolios being dragged more and more into a handful of names and more and more towards growth,” Gimber said, referring to the Magnificent Seven stocks (Alphabet, Apple, Amazon, Meta, Microsoft, Nvidia and Tesla).
“We think now is a good time to rebalance some of that out and explore the less appreciated parts of the US market.”
The skyrocketing returns achieved by the Magnificent Seven are linked to the excitement around artificial intelligence (AI), but it’s worth cashing in on some of those gains whether or not you believe the hype is justified, according to Gimber.
He thinks the US equity market’s returns will broaden out for two main reasons.
First, a colossal amount of infrastructure is required to enable the AI architects to deliver, leading to increased demand for clean energy, power distribution and the minerals used to produce chips.
“There is no AI revolution without the background infrastructure to support it,” he said.
“ There's no way today that grids in the US, the UK or elsewhere can cope with the kind of power demands that we see ahead. Electricity demand was already set to rapidly accelerate thanks to the energy transition and now you have this additional wave of demand.”
Second, the elevated earnings expectations for AI applications require much higher demand and many more AI consumers to justify them.
“That could be healthcare, manufacturing, financial services – but you do need a broadening out of earnings upgrades to justify the pricing that you see in some of the mega caps,” Gimber said.
If the AI-fuelled bull run continues (as BlackRock strategists and portfolio managers expect), so will these other sectors – therefore it would be worth rebalancing portfolios in their direction.
On the other hand, if the hype around AI dissipates, there could be a catch-down scenario within the S&P 500, where the valuations of mega caps fall to catch down with the rest of the market, Gimber warned.
Many other asset managers are trimming their overweight exposures to US tech on concerns that the Magnificent Seven trade has become too crowded, according to the latest Bank of America Global Fund Manager survey. Fund managers’ average allocation to tech stocks currently stands at a net 20% overweight, which is its lowest since October 2023 and has come down from a net 36% overweight in February 2024. It is below the long-term average of a net 22% overweight.
A similar rotation and broadening of returns is also likely to happen regionally, according to Gimber, who urged investors to look past the recent leaders to find stronger opportunities elsewhere.
“The discounts on offer in places like Europe and the UK now look too wide”, the strategist observed. The UK is trading on a roughly 45% discount to the US today – the widest level in over 35 years – and Europe (excluding the UK) at around a 30% discount, again a multi-decade record.
In some sectors the discount might be justified, he said, but not at these levels.
US financials for example have “arguably stronger” balance sheets and better returns on equity, so they do deserve to trade at a premium, according to the strategist, but the average discount for UK financials over the past 30 years is around 10% and today it stands at 45%.
There is a similar opportunity in the rest of Europe too, where every sector is trading at a larger-than-average discount relative to its US counterpart.
“This is where stock pickers have some pretty good opportunities to be picking off companies of frankly a similar quality but that are priced at much lower levels just because they're located in a less popular neighbourhood,” Gimber said.
“When you add onto that a broadening economic momentum and higher interest rates as growth holds up, you should start to see more cyclical parts of the market that are better tapped into the real economy also coming to the fore.”