VTHR - Flexibility Matters
2023-08-15 21:41:00 ET
Summary
- The U.S. equity market in 2023 has been driven by the disproportionate outperformance of large cap, growth, and technology-oriented stocks, leading to a significant concentration of market returns.
- The Large-Cap Growth and technology-oriented segments of the market are largely benefitting from investor optimism.
- The dynamic environment is creating a number of compelling special situation and opportunistic investments with idiosyncratic performance drivers.
By Richard S. Nackenson
The significant concentration of market returns is creating opportunity for alpha capture as investment styles quickly shift in-and-out of favor.
The U.S. equity market in 2023 has been driven by the disproportionate outperformance of large cap, growth, and technology-oriented stocks, leading to a significant concentration of market returns. We believe this discrepancy is creating opportunity to capture alpha elsewhere in the market as investment styles quickly shift in-and-out of favor.
We entered August with the S&P 500 up 21%, the Russell 1000 Growth returning 33%, and the Information Technology sector up approximately 50%. The Magnificent Seven (Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia, and Tesla) are responsible for 70% of the return for the S&P 500, a significant and outsized shift in market leadership from roughly a year ago. Big Tech’s impact has been further intensified by investors seeking exposure to artificial intelligence, which has resulted in about a 1,000 basis point gap between the S&P 500 Index and its Equal-Weighted counterpart. As a result, style disparity—which is the return difference among the best and worst performing “style box” segments—is approximately 25%, about 30% higher than the long-term average.
The Large-Cap Growth and technology-oriented segments of the market are largely benefitting from investor optimism. Stock appreciation for many of these companies has been driven by significant valuation multiple expansion, not by positive earnings revisions. Over 80% of the stock price appreciation realized by the Magnificent Seven has been due to an increase in valuation, versus less than 20% due to earnings improvement. We believe this disconnect has the potential to weigh on companies with elevated valuation multiples that do not deliver on optimistic growth expectations, especially in a higher interest rate environment that could pressure earnings multiples.
With investors overly focused on Large-Cap, technology, and growth companies, we believe many areas of the market have been overlooked. Equity investment styles have historically shifted in-and-out of favor quickly and with great magnitude. We believe there is an inherent benefit in having an equity strategy that may pursue the best investment opportunities regardless of market-cap size or style. This also includes the small & mid-cap space, as well as select value stocks, that are poised to benefit from a potential shift in sentiment. The dynamic environment is creating a number of compelling special situation and opportunistic investments with idiosyncratic performance drivers. Seeking out companies across sectors, market-caps, and styles, in our view, provides the ability to identify overlooked areas of the market and differentiate through stock selection.
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Flexibility Matters