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KEY POINTS
1. It's vital to look at market performance beyond the Magnificent Seven.
2. We believe the U.S. market has only recently begun to broaden.
3. In our view, less restrictive monetary policy and China stimulus could be the catalyst needed for cyclical sectors.
Earlier this year, we anticipated a broadening in the market beyond the high-flying Magnificent Seven1 (Mag 7), which has dominated much of the equity news cycle for much of the last two years. In late spring, we wrote about the Barra2 momentum factor being so stretched that it was at a level occurring only 3% of the time since 1995 (when factors began being measured). Excitement around artificial intelligence (AI) has driven much of the Mag 7 stock dominance this year, but given how extended the momentum factor was, we believed we were on the precipice of a market broadening. This began to come to fruition during the third quarter, with the S&P 500 Equal Weight Index outperforming the S&P 500 Index by 3.7%.
While the market is not quick to acknowledge that broadening, or its potential to continue, we dug a bit further, beyond this quarter. We examined the busy market period between January 2022 and September 2024, as we began to emerge from the post-pandemic period more meaningfully. Over that period, the Federal Reserve hiked rates 11 times and then subsequently started easing. During this time, the Mag 7 returned an impressive 41.7% (cumulative total return).
Less well-known, however, is that the Russell 1000 Growth excluding Magnificent Seven (by removing the Mag 7 stocks and accordingly reweighting and measuring the performance of the remaining 386 stocks in Russell 1000 Growth Index) returned 14.0%. Due to the continued dominance and increased percentage of the Mag 7 in the overall Russell 1000 Growth Index (53.4%), it is easy for the rest of the companies in the index to get lost behind the seven mega-caps. However, over the same period, the Russell 1000 Value Index returned 20.3%, over 600 basis points better than the Russell 1000 Growth Index ex-the Magnificent Seven. Meanwhile, the Russell 1000 Value Index maintained the lowest volatility (measured by standard deviation), at 6.38%. This compares to a volatility of 7.91% for the Russell 1000 Growth Index ex-the Magnificent Seven and 12.01% for the Mag 7 — almost double that of Value during the period between January 2022 and September 2024.
Source: FactSet, Russell. Past performance is no guarantee of future results. It is not possible to invest in an index. Data from December 31, 2021 to September 30, 2024.
We quickly concede that past performance is not indicative of future results, but it certainly provides a strong barometer for the importance of diversification. As we have previously written, our team delves deep into investor behavioral biases and trying to minimize them (and get our investors thinking longer term) using our proprietary library of portfolio exercises. We strive to guard against recency bias, which is prominent regarding the Mag 7 amid closely-watched headline performance.
It is always important to know what you own. The value of active management can be crucial in this context, particularly in less concentrated areas. Still, some investors are concerned the U.S. is expensive by some metrics. In our view, market concentration inflates this, and the U.S. market has only recently begun to broaden. Using the MSCI USA and MSCI ACWI Indexes as proxies, the ratio of next 12 months earnings per share (EPS) contribution from the U.S. has been consistently rising, confirming that the U.S. portion of the ACWI Index has been carrying the rest of the index and suggesting its increased share of the index is warranted.
Source: Strategas and MSCI. It is not possible to invest directly in an index. As of September 25, 2024.
We believe broadening of the U.S. market can continue. While MSCI USA Information Technology and MSCI USA Communication services led the way for EPS growth in 2024, energy, materials and health care sectors are expected to stabilize in 2025 and will drive the next leg of EPS acceleration for the MSCI USA. Given central banks are not starting rate cuts amid recession fears, we believe less restrictive monetary policy and China stimulus could be the catalyst needed for cyclical sectors. We believe that, in today's cycle, pairing economic cyclical exposure with defensive sectors that are either extremely cheap (health care/pharmaceuticals) or about to experience secular growth (utilities) could potentially offer opportunities for alpha.
Bottom Line: Our Opportunistic Value investment philosophy focuses on quality, leading companies that are mispriced or misunderstood by the market and trading at a discount to their intrinsic value. We believe markets such as these offer ample opportunity for active managers focused on bottom-up security selection.
1 The Magnificent Seven stocks are Alphabet Inc. Class A and Class C, Amazon.com, Inc., Apple Inc., Meta Platforms Inc., Microsoft Corporation, NVIDIA Corporation and Tesla, Inc.
2 The multi-factor model created by Barra Inc. is used to measure the overall risk associated with a security relative to the market.
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Disclaimers
Forecasts and/or estimates provided herein are subject to change and may not actually come to pass.
Russell 1000® Value Index is an unmanaged index of U.S. large-cap value stocks. Unless otherwise stated, index returns do not reflect the effect of any applicable sales charges, commissions, expenses, taxes or leverage, as applicable. It is not possible to invest directly in an index. Historical performance of the index illustrates market trends and does not represent the past or future performance of the fund.
Past performance is not a guarantee of future results.
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