The remarkable run enjoyed by US large-cap growth stocks may be nearing its limits, argues Ed Wielechowski, co-portfolio manager of Odyssean Investment Trust, who believes investors should consider the opportunities emerging in overlooked areas of the market, including UK smaller companies.
Over the past decade, US large-cap growth stocks – dominated by the largest technology names – have delivered outstanding returns, comfortably outperforming most other parts of the equity market.
It is little wonder these names have come to dominate market narratives, with many investors positioning themselves for the trend to continue.
We would argue against this consensus for two reasons. First, no market regime lasts forever – leadership rotates over time.
Second, one of the more durable truths in finance is that starting valuation is a powerful predictor of future returns.
This view is supported by recent data from Research Affiliates, which compares realised returns by equity category over the past 10 years with expected returns over the next 10, based on current valuations and how markets have historically performed from similar starting points.
The picture is striking. US large-cap growth delivered an annualised real return of around 14% over the past decade – leading other equity categories. Yet Research Affiliates’ model points to a markedly weaker next decade, with returns expected to be close to flat.
This softer outlook reflects the elevated valuations these stocks now command after such a strong run: in the end, valuation matters.
If US large-cap growth’s decade of leadership is coming to an end, where does the baton pass to? The data points to developed markets outside the US, and smaller companies within them in particular, as the standouts for expected returns over the next decade.
This resonates with the case we have been making at Odyssean Capital for some time.
We believe that within non-US developed markets UK smaller companies stand out for the value they offer, both relative to their own history and to international peers. In our view, attractive starting valuations are the foundation for a period of multi-year outperformance.
The exact timing of a change in market leadership is impossible to call with precision. But the underlying drivers are compelling, and we believe investors should be positioning for a change in the market weather.
Main image: speech bubble, volodymyr-hryshchenko-V5vqWC9gyEU-unsplash
