1. The Return of Diversification
At the start of 2023, a small group of seven companies dominated the S&P 500, accounting for less than 20% of the index but generating two-thirds of its annual returns. This group has continued to lead the market in 2024, increasing its weight to almost 30% of the index and bringing market concentration to levels not seen in 50 years.
However, this trend appears to be changing. With the negative performance of Tesla and Apple this year, the group has been reduced to five companies. By the end of 2023, an increase in market breadth has been observed, a trend that is expected to intensify in 2024. This change is due to the improvement in the profitability of the “S&P 493” and small and mid-cap companies .
Historically, market concentration has been high in periods of economic uncertainty. As macroeconomic uncertainty decreases, market breadth tends to improve. This is what is being observed now.
2. The Resurgence of Small Caps in the US
A moderate growth environment is anticipated along with moderate inflation and interest rates, creating a favorable environment for small and mid-cap companies. Although we have already written an article mentioning this, it is worth remembering. These companies were laggards in 2023 and have significantly underperformed the indices for most of the last 13 years. Small caps have not been so undervalued relative to large caps since the dotcom bubble.
In addition, the small- and mid-cap universe is becoming increasingly inefficient due to lower analyst coverage, increased trading in ETFs, and the rise of unprofitable companies in the Russell 2000 index following the SPAC boom in 2020-2021. These companies are believed to be on the cusp of entering a period of positive profitability, particularly benefiting active investors.
3. Rediscovering Value in the Value Segment
Like small caps, value stocks have lagged in 2023 and for much of the last decade, although they showed signs of recovery in Europe and Japan last year. This trend of underperformance has continued in 2024, improving US stock indices, more concentrated in mega-cap values and in certain sectors and more growth factors. Investors who use these indices as a reference are increasingly exposed to these concentrated areas.
Unlike funds oriented to the growth segment, which face the risk of a change in trend, Value stocks offer an attractive combination of upside potential and diversification. Value allocations can focus on quality, thematic or individual opportunities, and dividends for those seeking income, especially as interest rates begin to stabilize.
4. Japan: A Different Renaissance
Over the past 30 years, Japan’s nominal GDP growth has been virtually zero, but recently it has been between 3 and 5%. The Japanese economy, fueled by strong wage growth and corporate pricing power, appears to be leaving its long-standing deflationary environment behind. Investors are optimistic due to business reforms focused on return on capital, although this process will take years.
These changes occur against a backdrop of attractive valuations. Despite recent gains, andThe Japanese equity market continues to have historically low valuations, trading at two-thirds the multiple of the United States. This is seen as an attractive entry point for investors, into what appears to be a rally driven by strong fundamentals.
Equity diversification offers multiple opportunities in the current environment. Market broadening, the resurgence of small caps, the rediscovery of value stocks and Japan’s economic renaissance present attractive options for investors. Adapting portfolios to take advantage of these trends can provide sustainable returns over the long term, mitigating the risks inherent in a constantly changing market.
Article based on a Wellington Management report
