The S&P 500 Index reached an all-time high in mid-February, driven to a large extent by the performance of a handful of mega-cap technology stocks. But can such concentration of returns persist, and what are the options for an investor seeking to build a diversified equity exposure in the US?
Daniel Casali, chief investment strategist at wealth management company Evelyn Partners, says: “In 2023, the select group of Apple, Microsoft, Alphabet, Amazon, Nvidia, Meta Platforms and Tesla returned an incredible 107 per cent, far outpacing the broader MSCI USA index, which delivered a relatively subdued but still healthy 27 per cent to investors.”
Those seven stocks now represent more than 28 per cent of the total index.
Casali says the current health of the US economy and its corporate sector will mean a broader range of stocks drive market returns this year.
“Companies have adeptly raised their prices, passing on the impact of higher inflation to their customers,” he says.
“Although wages have risen, they haven’t kept pace with those price rises, leading to a decline in employment costs as a proportion of the price of goods and services. Factors, including China joining the World Trade Organization and technological advances, have enabled an increased supply of labour and accessibility to overseas job markets. This has contributed to improving profit margins, supporting earnings growth.
“We see this trend continuing. Even if margins contracted slightly and there was only modest growth in company sales, our analysis suggests that company earnings could continue to grow. Consensus forecasts project 11 per cent growth in earnings in 2024, which is possible,” Casali adds.
Small caps performing well
It may not be as simple as moving further down the market-cap scale, according to Kepler research analyst Alan Ray, who says that while much focus has been on the gains made by the large-cap indices, “the smaller companies index – the Russell 2000 – did relatively well in 2023, rising 17 per cent”.
“But, like the large-cap index, a narrow group of sectors led performance, and two-thirds of sectors underperformed. Small caps are more sensitive to interest rates, and to inflation, and so with hindsight this gap is explicable. Higher debt costs and inflation make life harder for smaller companies – the market knows this and reacts when rates rise,” Ray adds.
One feature of the US economy of late has been the resilience of gross domestic product growth, occurring at the same time as markets ponder the possibility of interest rate cuts.
Analysts at consultancy GlobalData TS Lombard think one positive feature of US markets is that equities are no longer whipsawing based on investor expectations around monetary policy, but instead are focused on the actual GDP data being positive, and on company earnings, which have generally been robust.
But their view is that with valuations already high, “expensive US valuations limit the upside in the medium term, although positioning data suggests investors are still managing risk carefully. We prefer Europe to the US, and remain cautious on China”.
