Fast reading
- The S&P 500 reached a milestone of 5,000 for the first time ever last week, with a small pool of companies continuing to push the benchmark upwards and bringing gains to nearly 5% since the beginning of the year.1
- Macro releases this week confirmed several countries fell into recession last year, including the UK, however investors argue that the positive AI narrative continues to outweigh any negative news flow.
- Elsewhere, US retail sales data released on Thursday showed spending fell more than expected in January, with sales declining by 0.8% after a strong Christmas period for retailers.
The wild, wild west
Eyes have been fixed to the S&P 500 in the first weeks of 2024, with the index being driven to record-breaking new highs by the so-called ‘Magnificent Seven’ top blue-chip US companies: Apple, Meta, Amazon, Alphabet, Nvidia, Microsoft and Tesla.
The rally has undoubtedly been powered by this core group of stocks, but for Mark Sherlock, Head of US Equities at Federated Hermes Limited, there is still value and opportunity to be found for investors outside of these headline-grabbing names.
“One area of particular interest to us now is those companies at the lower end of the market cap spectrum – ‘SMID’ companies with a market capitalisation of c.US$1bn-US$15bn. Valuations in this part of the market are much more reasonable with stocks, in aggregate, currently trading on a 30% discount to their larger-cap counterparts (historically they traded at a 10% premium).”
For those with concerns over the current levels of valuation for SMID companies, Sherlock points to further benefits of looking beyond the big names.
“If you add to that the more diverse industry exposure, a larger tilt to the solid domestic economy and their potential to benefit from large levels of fiscal spending, these factors serve as a useful reminder that there are many different ways to benefit from investing in US companies outside of mega-cap tech.”
Figure 1: Performance of the Magnificent Seven stocks, combined, 2023, versus S&P 500
As we enter the tail end of earnings season, over half of the companies within the index have posted their quarterly earnings. Nvidia, one of the largest names in big tech, is set to release its quarterly report next Wednesday and analysts will no doubt be paying close attention to the results.
“Semi-conductors continue to see a remarkable disparity in results, with more traditional manufacturers frequently struggling – and seeing their share prices punished – while AI exposures continue to be favoured,” explains Lewis Grant, Senior Portfolio Manager at Federated Hermes Limited. “Nvidia’s earnings and outlook will be taken as a proxy for how far the AI and Mega Cap themes can run and may have a large bearing on the overall market direction for the foreseeable future.”
Although the bulls remain firmly in control for now, Grant believes there are factors that could break the spell for equity markets over the coming weeks.
“Persistent inflation appears the most likely candidate to break the status quo and prompt volatility to surge, although investors have thus far largely overlooked the fractious and worsening geopolitical outlook,” he says. “We continue to advocate caution, diversification and profit taking.”
Nvidia’s earnings and outlook will be taken as a proxy for how far the AI and Mega Cap themes can run and may have a large bearing on the overall market direction for the foreseeable future.
Tighten the purse strings
US retail sales data released by the Commerce Department on Thursday indicated that American spenders felt the pinch post-festive period and against a backdrop of elevated interest rates, with spending declining by more than expected in January and signalling the second decline over a ten-month period.
Phil Orlando, Chief Equity Strategist at Federated Hermes Inc., considers the impact the latest data could have on markets ahead of the Fed’s mid-March meeting.
“Bonds could rally, as worse-than-expected retail sales suggest that the economy and inflation are cooling more quicky, which could keep the Fed’s first interest cut on the table sooner rather than later. But stocks could diverge and sell off, as expectations for weaker-than-expected GDP growth and corporate profits could weigh on stock valuations, which stretched after a 23% SPX rally from October 27, 2023, to a new record high on February 12, 2024. Stocks have rallied by 6% since the beginning of the year, and stocks are due for a healthy near-term correction to remove some of that froth.”
To learn more about our US SMID strategy, please read this Q&A with the fund manager.
And to hear more from our investment team, please read our 2024 Outlooks.
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1 The Financial Times, as at 9 February 2024.
