Global mid-caps: postcard from the USA

Resilience of the US economy

"It's the economy, stupid!" So quipped James Carville, a strategist in Bill Clinton's successful 1992 US presidential election against incumbent George H. W. Bush. Fast-forward three decades, and the phrase continues to resonate.

I recently attended the Raymond James US Equities Conference in Orlando. Last year, nearly all investor questions and discussions centred on inflation and monetary policy. One year later and the US Federal Reserve (Fed), arguably more than many other developed market central banks, has successfully tamed inflation. The February reading was 3.1%, down from the peak of 9.1% in June last year. Most delegates believe we’re at peak interest rates (5.25-5.50%), and cuts are on the cards for 2024 [1].

Recent economic data highlight the resilience of the US economy. GDP grew 6.3% in 2023, which blew other major economies out of the water. Even China, the Asian Tiger, has failed to roar back to life.

Positive US company outlooks, with 2024 expected to be a ‘normal’ year despite the US presidential election.

Positive company management commentary mirrored the more upbeat assessment of the US economy. True, they’re rightly conservative in setting guidance for 2024. But most were looking forward to a ‘normal’ year following the tumult of Covid, Ukraine, China’s extended shutdown and more. And who can blame them?

Meanwhile, politics will return to centre stage as some 70 countries, representing over half the world’s population, go to the polls. The upcoming US presidential election, a rerun of Biden versus Trump, looms large. What I find fascinating is that while the US economy has demonstrated resiliency, Biden and the Democrats are not getting much credit from voters, especially blue-collar workers.

Neither Biden nor Trump is loved by the majority. Concerns around Biden include his age/fragility, increased migration, and continued support of funding for Ukraine. Worries about Trump include his unpredictable, confrontational nature. This could see him threaten world order and democracy by pulling the US out of NATO. It seems the choice facing most Americans is: ‘Who do I hate less?’. That’s not going to heal the political divisions in the US.

This might be a simplistic British view, but I don’t think there’s a significant difference in economic policy between the two candidates. Both are capitalists (of differing hues) who want to see ‘America be great (again)’. President Biden, for his part, launched the Infrastructure Investment and Jobs Act, and CHIPS and Science Act, which are helping to drive reshoring trends. 

Anyway, back to the purpose of the trip: to meet great companies. Two in particular stood out. 

• Martin Marietta (US) – natural resource-based building materials company. Its products (namely aggregates) are used in infrastructure, non-residential and residential construction projects. Management guidance and consensus estimates still appear too conservative. Pricing is likely to remain stronger for longer. The company’s capital reserves should accelerate M&A activity. There are also green shoots coming through on volumes for end markets linked to infrastructure projects. 

• Stantec (Canada) – engineering services company. Management noted organic revenue growth should be higher than in the past due to strong structural, secular multi-year tailwinds. These include population growth and growing urbanisation, infrastructure investment and stimulus, reshoring, and increasing focus on sustainability. We own shares in a close peer, WSP Global (Canada). It’s the most consistent performer in its sector over the last 15+ years, averaging steady organic growth. Stantec is exposed to the same growth drivers as WSP. We think further upside could come from M&A activity.

Global portfolio managers remain ‘long’ US, particularly large-cap tech/ Magnificent 7

Many global portfolio managers I spoke with said they were overweight the US. This is due to two main factors:

• An increasingly concentrated market dominated by US large-cap tech – the Magnificent 7 emerged in 2023, a group of tech stocks (Apple, Meta, etc.) responsible for more than 60% of the S&P 500 Index returns last year. Index concentration is at multi-decade highs, with the largest 10 companies by market cap making up almost 30% of the US equity market [2].

• Deliberate geographical positioning – there’s been a move away from overseas geographies due to economic malaise, poor/incoherent fiscal policy and rising geopolitical tensions. Indeed, one Edinburgh-based global portfolio manager who’s long-term bullish on Asia proudly told me he holds zero Chinese stocks. Many shared his view, highlighting China’s sputtering economic growth and/or rising geopolitical tensions.

Can the dominance of US large-cap tech and the Magnificent 7 continue? I think that’s difficult to answer at this stage. However, it does highlight the risk investors are taking by putting all their eggs in one basket. It also confirms now is a perfect time to think about diversification and to look further down the market cap scale at mid-caps. There are a few reasons I believe this.

• Interest-rate sensitivity – with inflation moderating, central banks across most developed markets are expected to cut interest rates. This should be good for mid-caps, as well as growth equities. History shows US mid-caps climbed after the first rate cut and went on to outperform large caps over three, six and 12 months. I see no reason why this time will be different. 

• Valuations – given heightened expectations, US large-cap tech and the Magnificent 7 need to deliver sizeable earnings beats to justify their valuations. By contrast, expectations for US and global mid-caps are lower. There’s a greater chance of earnings surprising to the upside as a result.

• Markets move ahead of the macro – S&P US mid-cap data dates back to December 1990, covering the last three recessions (2001, 2008-09 and 2020). It showed that late in the economic cycle, US mid and large caps traded broadly in line. However, shortly after the start of a recession, investors started to favour mid-caps as they positioned themselves for the recovery. To use a cliché, ‘the early bird catches the worm.’ 

Final thoughts…

As investors, we seek to provide diversification in an era of significant concentration risk. Most global equity funds’ top-10 holdings are US large-cap technology names in a slightly different order. Our top 10 looks completely different, offering clients diversification by geographies and sectors. We invest in companies with quality, growth and momentum characteristics. That means:

• firms with innovative/disruptive business models 

• higher earnings visibility or predictability

• resilient or dominant in their market niche 

• growing due to structural trends

In short, we look for the mid-caps that can potentially become the large caps of tomorrow. That’s why we think clients should consider the asset class as part of the core global equity allocation. 

1. Source: US Labor Department, March 2024
2. Source: JPMorgan, February 2024

Anjli Shah is investment director at abrdn.

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