2023-07-03 07:51:32 ET
Summary
- The U.S. stock market has performed well in the first half of 2023, with large-cap tech companies leading the way and the Schwab U.S. Large-Cap Growth ETF up around 35%.
- Factors contributing to this strong performance include surging U.S. nominal GDP, the potential for future rate cuts by the Fed, and the transformative impact of artificial intelligence on large cap growth.
- Despite past market calamities, we believe long-term risks to U.S. equities are minimal and that being aggressively long U.S. stocks, particularly large cap growth, makes a lot of sense.
By Brian Nelson, CFA
The U.S. markets continue to showcase the importance of stock selection as the strongest, large-cap tech companies continue to distance themselves from the pack. The Schwab U.S. Large-Cap Growth ETF ( SCHG ) is up ~35% so far this year, while the S&P 500 ( SPY ) is up about half of that, while small cap value, as measured by the iShares Russell 2000 Value ETF ( IWN ) and dividend growth strategies, as measured by the SPDR S&P Dividend ETF ( SDY ), are roughly flat. The U.S. stock market has done well so far through the first half of 2023, and we think there are four main reasons why investors should be aggressively long U.S. equities.
U.S. Nominal GDP Continues to Surge
Nominal Gross Domestic Product for United States. (St. Louis Fed)
So much emphasis has been placed on inflationary pressures that investors may be missing the big picture. Once the current episode of elevated inflation in the U.S. passes, which looks to be sooner than later, the U.S. economy will be at nominal levels of GDP that are significantly higher than those of even just a few quarters ago. The economic backdrop in the U.S. may be concerning for some areas of the labor market and in certain subcategories of real estate, but the undercurrents that are driving higher levels of economic activity are significantly positive for the U.S. equity markets in the longer run.
Stocks are priced nominally and not on a “real” (inflation-adjusted) basis, and we’re liking what nominal GDP means for long-term equity prices. We expect continued strong performance out of U.S. equity markets, and think the recent 12-18 months of elevated inflation has acted as a step-change of intrinsic values that won't be completely factored in until inflation, itself, is tamed, which looks like it will happen before the end of this year. Once investors move beyond concerns about inflation, they will be looking at current levels of U.S. nominal economic activity, which continues to boom.
The Fed’s Dry Powder When It Eventually Cuts Rates Again
Higher interest rates are generally negative for equity prices (higher interest rates translate into higher discount rates), but after one of the most aggressive rate-hiking cycles in history, the Fed may not have much more left to do. Many have argued that the Fed has been behind the curve when it came to raising rates and that it has gone too far too fast, but all of this is now behind investors.
The U.S. markets are now in a very good position, and instead of viewing the current federal funds rate as being restrictive, investors should view it as future dry powder. In the event that there may be any trouble down the road with respect to the U.S. economy, the Fed has significant dry powder with respect to future rate cuts to stimulate activity. This translates into considerable option value.
U.S. markets are only 5%-10% off of all-time highs, too. Quite simply, almost every investor should be extremely happy to have swapped a mere 5%-10% decline in the S&P 500 for future dry powder in the form of future rate cuts from the current federal funds rate north of 5%. We can't be more pleased with the situation and expect money to continue to flow into equities as a result.
Artificial Intelligence to Propel the Area of Large Cap Growth Further
Artificial intelligence [AI] is going to change the world, in our view. When we first tried out generative AI via ChatGPT a number of months ago, we were extremely impressed by the nascent technology, especially as it relates to its human-like abilities with respect to creative instruction such as writing poems and the like.
Though there may be some over-excitement about today’s existing AI technology behind large language models, from our perspective, AI will change our lives in almost every way imaginable from education and shopping to search and gaming and beyond. There are probably many other areas that AI will impact that investors haven’t even thought of yet. This article's summary bullet points, for example, are largely written by AI.
Large cap growth has trounced the area of small cap value since the release of the first edition of the book Value Trap. (Trading View)
Not only is the U.S. market backdrop strong as we have outlined above, in our view, but AI has become the latest catalyst to propel the area of large cap growth, which continues to outpace other areas of the market. Apple ( AAPL ), Microsoft ( MSFT ), Amazon ( AMZN ), NVIDIA ( NVDA ), and Alphabet ( GOOG ) ( GOOGL ) top many large cap growth ETFs, and these firms should continue to see tremendous interest as investors play catch up to their allocations in this area.
We continue to like the area of large cap growth and believe the two main cash-based sources of intrinsic value -- net cash on the balance sheet and future expected free cash flow -- will continue to rule the day.
Long-Term Risks to the U.S. Stock Market are Minimal
Markets were flooded with liquidity during the Great Financial Crisis [GFC] and the biggest banks were bailed out in 2007-2009, and these moves have marked, in our view, the beginning of a new risk regime. However, it wasn’t until the fallout in the markets during onset of the coronavirus pandemic that our belief the U.S. markets would continue to move ever higher was strengthened.
Every historic stock market calamity from the Crash of 1929 to the Crash of 1987 to Lehman Brothers during the GFC has been met with the markets setting new highs again. With dollar cost averaging, investors made money during the worst of times, too. The recent implicit deposit guarantees beyond FDIC insurance thresholds during this year's regional banking crisis once again helped to support that long-term risks to U.S. equities are minimal.
It has paid off to be aggressively long U.S. stocks, and we expect that to be the case for years to come. The one trade for the next decade, as was for the last decade, continues to be aggressively long U.S. equities in the form of large cap growth. The largest and strongest large cap tech names leveraged to AI may very well continue to stand head and shoulders above all else.
This article and any links within are for informational and educational purposes only and should not be considered a solicitation to buy or sell any security. Valuentum is not responsible for any errors or omissions or for results obtained from the use of this article and accepts no liability for how readers may choose to utilize the content. Assumptions, opinions, and estimates are based on our judgment as of the date of the article and are subject to change without notice.
For further details see:
4 Reasons To Be Aggressively Long The U.S. Stock Market