US outlook: The end of the mega cap-driven market?

“No longer a mega cap-driven market”

The so-called ‘Magnificent Seven’ stocks (Alphabet, Amazon, Apple, Meta, Microsoft, NVIDIA and Tesla) garnered all of the headlines in 2023, because of their size and impact on the performance of the S&P 500. From our point of view, US Select’s exposure to Meta and Amazon added significantly to performance. In addition, a range of our mid-cap holdings (such as Constellation Energy, SAIA and Builders FirstSource) also made good contributions. This was a timely reminder that there is a range of opportunities in the US equity market away from the very largest stocks. In the US Smaller Companies fund, performance was helped by our identifying very positive dynamics in a couple of domestic industries. We recognised that demand in the housing sector is likely to remain robust despite higher interest rates and that recent legislation will support infrastructure spending and domestic investment.

Looking ahead to 2024, we would expect to see a couple of sectors that we already favour continue to recover. These include housing and infrastructure spending, as mentioned above. Beneficiaries among our holdings include Builders FirstSource, TopBuild, Clean Harbors and Eagle Materials. We also still think that there are a couple of sectors that have not yet normalised following the pandemic. One of these is the memory-related technology sector. After a boom in demand followed by a period of oversupply, pricing collapsed. We believe pricing has now stabilised, and we are on the path to strong recovery given supply demand is much more in balance. We have a holding in Western Digital, which sells both hard disk drives and NAND flash memory, to capture this dynamic.

More broadly, the Federal Reserve has indicated that interest rates are likely to decline in 2024. This is generally an environment that favours US smaller companies.

“Highly polarised market creates opportunities”

As Cormac outlines above, for US equities, 2023 was defined by concentrated performance in a handful of megatech stocks, huge polarisations in sector performance and the consequent dramatic underperformance of the average and smaller company.

The fund’s performance during the year, while slightly lagging the very strong market, came from a combination of having some of the megatech stocks, having a sizeable overweight in housing-related companies, and some stock-specific stories like the utility Constellation Energy (nuclear power, a beneficiary of recent clean energy legislation).

The polarisation in the market has led to very wide dispersions in performance and valuations between different sectors. This has created very interesting opportunities, on both the long and the short side.

One sector we would note is life sciences. We think life sciences are currently going through a cyclical downturn because of delayed normalisation after the pandemic boom. This has been compounded by weakness in capital markets which is reducing funding for early stage biotechs. We believe that it is only a matter of time before the currently high inventory levels normalise, and strong top-line growth returns. This should be very helpful the fund’s holdings in Avantor, Thermo Fisher Scientific and Icon Labs, which we believe trade at attractive valuations relative to their potential growth outlook. 

Find out more about our US equities fund range