2023-11-03 06:00:00 ET
Summary
- The case for investing in US equities remains mixed over multiple time horizons, but in my opinion is compelling looking 3+ years ahead.
- Large-cap US stocks have been the major wealth creators over the past decade, and the Vanguard Large-cap Index Fund offers diversified exposure to this segment.
- The debate on whether to allocate to US or non-US equities continues, with US equities trading at a premium and potential opportunities in European and Japanese stocks.
Investment brief
The case for allocating to U.S. equities remains mixed when considering multiple investment horizons. The Fed's decision to pause its hiking cycle in yesterday's policy meeting is a critical factor that will guide equity returns over the coming 12 months. Valuations, market, breath, and technicals must also be considered. In addition, the comparison of U.S. stocks to their global pairs is something that must be heavily weighed into any investment reasoning.
Already we’ve seen equity markets rally in the short term following the policy meeting for November. The question investors must now ask themselves on the strategic side is, where do I park my hard-earned capital, and what are the most compelling investment opportunities over the coming 12 months to 3 years? Long-term, in my opinion, domestic equities still remain the most compelling case for the compounding of wealth. However, a more thoughtful analysis must be completed on the geographical allocations for equities.
Large-cap stocks have, for the most part, been the major wealth creators over the past decade for U.S. investors (and globally for that matter). This remains true over the past 12-month period as well, with the "magnificent 7" companies holding up the broad indices over the October '22 to August '23 rally.
For those seeking diversified exposure to a large selection of domestic large-cap stocks —but without the excessive concentration in tech—the Vanguard Large-cap Index Fund ( VV ) is one offering that may be considered.
The fund invests across a diversified index of large U.S. equities, which comprise around 85% of the total U.S. market value. It has $26.8Bn in AUM and charges an expense ratio of 4bps on this. Dividends , which are paid quarterly, currently yield 1.5% on a trailing distribution of $3.00 per share.
One of the more compelling factors with VV, is that its weighting across sectors seems more balanced than adjacent large-cap funds. The allocation to healthcare and financials, at 13.5% and 12.4%, respectively, are notable factors. Moreover, the top 10 holdings of the fund comprise ~30% weight, and it has 544 holdings in total. This, as annualized turnover is only 3%, c.90% lower than comparable peers.
Figure 1.
VV tracks the CRSP U.S. large Index , and has a tracking error of 0.86% over the last 3 years, putting it in the top percentile of funds tracking large-cap constituents.
Like the majority of the broad indices, it recently broke its 200DMA in September/October, and it has been trading below its 50DMA since July, when equity markets began to roll over. Despite mixed opinions on the outlook for domestic equities over the coming 12—18 months, my judgement is that large-cap U.S. stocks still offer a compelling long-term risk/reward calculus, which warrants VV‘s inclusion into a strategic equity allocation in the long account of a long-term investor’s portfolio, in my opinion.
As such, my recommendations across all 3 investment horizons is as follows:
Fundamental—
- Short-term (next 12 months)- Neutral; Starting valuations still high vs. peers and macroeconomic crosscurrents remain a risk to equity markets. No saying on what the Fed may do beyond '23 as well. Growth stocks continue to be hammered as well.
- Medium-term (1-3 years)- Bullish; Sales + earnings growth projections remain very robust in the U.S., along with GDP projections. However, there remains a debate of factors and sizing at this point—value factors may continue to outperform in a continued selloff. Nonetheless, the scope for continued upside in the coming years is compelling in my view.
- Long-term (3+ years) - Bullish - Long-term U.S. growth remains compelling, and one cannot discount the speed of innovation, market efficiency, and importance of U.S. capital markets. I am bullish over the long term.
Technicals—
- Short-term (coming days to weeks): Bullish; improving short-term technicals which are showing bullish reversal off October lows, chance to harvest short-term upsides. Beyond this, range trade is supported vs. directional view.
- Medium-term (coming weeks to months): Neutral; no confirmation to expect a bullish move just yet. Could change if equity markets rally post Fed numbers.
- Long-term (coming months): Neutral; still plenty of room to cover to get us back in longer-term trend.
Net-net, considering a long-term investment horizon, I rate VV a long-term buy based on the factors raised here today.
Figure 1a.
Talking points
- Fed on pause for the time being
The big news this week was the Federal Reserve leaving interest rates unchanged at its policy meeting for November, marking the 2nd time it had decided to hold the FFR steady. However, the Fed's chair, Jerome Powell, wasn’t so constructive on the rates/inflation access, noting that there is still work to be done in bringing the level of inflation down, and that further rate hikes aren't not be off the table at future policy meetings.
Power was quoted stating, “I will say that we’re not confident this time that we’ve reached such a stance, we’re not confident that we haven’t" , referring to whether or not financial conditions had reached a restrictive level enough level. Talk about uncertainty and covering both ends.
However, he also remarked that "[y]ou’re close to the end of the cycle. That was the impression, I believe as of September. It’s not a promise or a plan for the future”.
What this means for equity markets remains to be seen in the short term. But one thing is for sure—stock markets did enjoy the news, with the S&P 500 futures rallying around 60 points from the open as I write. In fact, all markets are up on the day. This may be the turning point for large-cap equities, although more time will be needed for the market to digest the data. In my opinion, if there is another pause at the next policy meeting, this may be bullish for equities in the large-cap space. I would encourage all investors to pay very close attention to the markets' response to this latest policy meeting to gauge what might happen moving forward.
- U.S. vs. non-U.S. allocation debate continues to roll on
The debate on whether to continue allocating to domestic versus ex-U.S. equities continues well into the back end of the year. It’s no doubt that U.S. stocks have enjoyed a period of substantial outperformance versus their European and Asia-Pacific counterparts. With tightening financial conditions in North America in general, there is scope to potentially allocate to European-based names and Japanese stocks. For instance, the European index's trade at a significant discount to their American counterparts, which may bolster the next 12 months' returns. Meanwhile, U.S. indices are still priced at a premium to both global peers and historical averages over the last few decades, as seen in the figure below.
Figure 2.
Source: Goldman Sachs Macro Research
In fact, the crowd at Goldman Sachs ( GS ) are equally as mixed on the opinion of forward U.S. equity returns. Peter Oppenheimer, The firm's global portfolio strategist, weighed into the debate, stating:
T he exceptionalism of the U.S. equity market that has characterized the post-GFC era has had several drivers. Chief among them has been the collapse and global interest rates, which has benefited longer, duration and assets that the U.S. market has relatively more exposure to, as well as the U.S. is relatively low weight in areas of the market that suffered from significant headwinds, like financials and commodity stocks."
Oppenheimer goes on to acknowledge the success of the U.S. tech sector and that earnings growth in tech has faded since we rolled out of the "pandemic era".
Figure 3.
Source: Goldman Sachs Macro Research
We shouldn’t overlook the concentration of the U.S. indices, either, where the “magnificent 7” companies continue to prop up the benchmark performance, as mentioned earlier. The largest 15 companies on the U.S. exchanges have gained around 25—30% in value this year to date. However, the remaining selection of stocks has underperformed on aggregate, underperforming cash and/or investment-grade corporates.
As a result, the risk/reward calculus for large-cap equities remains a function of the many macroeconomic crosscurrents that are currently feeding into global markets. The rates/inflation access, a new commodities super-cycle, and geopolitical risks are all factors to be considered. On this basis, combined with the relatively high multiples that the U.S. still commands, and a contracting equity risk premium, the case for allocation over the coming 12 months may be limited. Beyond that, U.S. GDP forecasts have been increased consistently since December 2022, with the latest forecast, as of September 2023, calling for a 1.8 percentage point change from December projections. GS' projections for U.S. benchmarks are observed in Figure 5.
Figure 4.
Source: Goldman Sachs Macro Research
Figure 5.
Source: Goldman Sachs Macro Research
- Next 12 months returns outlook mixed
The other point to consider is starting valuations for VV, which still rest at a significant premium to adjacent peers. The fund trades at 20.3x earnings, ahead of the broad average of 15.2x, and well ahead of FactSet's 5.6x segment average. Dividend yields of <2% and a trailing payout of $0.72 are not enough to overcome this dilemma. As a reminder, starting valuations have a significant impact on the coming 12-month returns, and with European indices trading at such compressed multiples, this may be a risk factor for VV over this duration.
Nonetheless, equity flows into the fund over the past 12 months have remained reasonably positive (Figure 6), with 2 large drawdown periods over this time. In recent months, fund flows have averaged positive. With the recent policy decisions discussed earlier, there is scope for additional capital to flow into VV in my opinion.
Figure 6.
Technical considerations
1. Momentum over mid to long-term
Mid and long-term momentum studies are contrasted. On the daily frame, investors have lifted the bid off VV's 6-month lows and are now pushing it back toward September highs. Taking the 20DMA of highs and lows shows VV has been setting lower highs and lower lows since August, but a break in the price line above these ranges would be significant. The MACD has been trending lower, with 2x bearish crosses since July.
On the weekly, there's been a bearish cross of the MACD in October, after the rally sustained from '22—'23, so longer-term momentum looks to have slowed down for the time being. Going forward, you'd need a sharp reversal towards the $200s to suggest we are bullish again.
Figure 7.
Figure 8.
2. Skew, directional bias of price distribution
- Observations: September saw U.S. almost complete a full distribution, and we expected to open October lower, which we did. On the price usage chart (Figure 9) there's a high volume node ("HVN") at the $195s forming into a ledge which I estimate investors will continue filling until it matches the superior ledge + HVN above $205, which formed a vacuum + gap down in September which has since been a magnet for price (Figure 10). Price targets are collated at this region too (Figure 11). There is a pocket of low usage between $195 and $203, which could attract price usage—especially if stocks rally after the Fed's numbers. We already see high price usage and a 2nd HVN at the $200s with another ledge forming here. The corresponding low usage pocket may attract range trade as the distribution fills. Data is positively skewed, which supports this rotational view with sharp snapback rallies. As we're in an under-developed curve, I wouldn't play a direction at this stage, but look to price rotation between these key levels.
- Key levels: $195–$205 is the key range, between the 2 HVN's and filling the low-usage pocket in this area. If price remains trapped here, sideways action would be the minimum expectation.
- Actionable strategy: Avoid the breakout for now, until we see further ledge development from $195–$200. Longs beneath $195 are supported to sell the top of value above $205. Rotational trade is thus supported, unless we cut through the $195-$205 region at pace—then we'd need to re-evaluate this.
Figure 9.
Figure 10.
Figure 11.
3. Directional trend bias
Again the trend picture is contrasted across different time horizons. The following discussion illustrates this.
Figure 12 . Short-term (60-minute chart, looking to coming days)—
Observations + key levels:
- Bullish view is warranted in the short-term given 1) Fed notes, 2) bounce from October lows, and 3) bullish cross into the cloud.
- We have already retraced 61.8% of the October down-leg and could push to the $198s as the next level. $201 would capture the previous high.
- Lagging line is about to nudge above the cloud which is a bullish signal and the turning line crossed the base line in a bullish setup too. A pinch at the cloud could see U.S. trending from here.
- Look to $198 then $201 as the next upsides, $192 then $190 as downside areas.
Figure 13. Medium-term (daily chart, looking to the coming weeks)—
Observations + key levels:
- August saw the large engulfing pattern at A with subsequent gap down which didn't get retaken in September, resulting in a sharp reversal below the cloud by month's end.
- Marabzuzo line at B was taken in same month and was the top of the cloud until November. Three waves down and we bottomed last month at C.
- Price gaped above the marabuzo line from October in today's session at D and this could be a bullish sign. But we still are beneath cloud support, both turning + conversion lines are trending lower. Lagging line is well behind.
- Net levels to watch are $200 above the cloud by mid-November, then $204 beyond this. Finally, $208 would take out the August highs. Below $190 on the downside is bearish.
- Right now I'm neutral on this setup.
Figure 14. Long-term (weekly chart, looking to coming months)—
Observations + Key levels:
- Bearish engulfing at 1) is the long-term resistance that must be retaken to capture '22–'23 trend.
- Critically, we are heading to October Marubozu line with this week's candle at 2), which is itself a Marubozu with little downside shadow.
- We need to take out $196, then $200, then $203, key level from back in July at 3). We are still above the cloud, and lagging line just bounced from cloud top, a very good sign.
- Key levels are those from above, and we need to avoid <$195 on the downside, anything below $190 could see U.S. push to $180–$185 in my opinion.
- Again, I am neutral on this setup.
Discussion summary
Market tensions remain on the strategic side, in allocating to U.S. vs. global equities, and large-caps vs. SMID caps, notwithstanding the opportunity cost of holding cash/investment grade corporates right now. VV's diversified holdings that aren't overly concentrated in tech have enabled it to capture upsides this year without some of the volatility in adjacent indices. The coming 2-3 months will be critical for stocks and guide positioning into the new year. There is scope for an end of year rally, seeing the Fed's moves in its November meeting. Still, starting valuations remain high for VV, and this may compress coming 12 months returns. In that vein, I am neutral on the fund over this duration, but from 1–3+ years remain bullish on fundamentals and U.S. economic prospects.
For further details see:
VV: Long-Term Constructive On U.S. Large Caps, Improving Technicals In Support