Indiana Trust Wealth Management
Investment Advisory Services

by Clayton T. Bill, CFA
Vice President, Director of Investment Advisory Services

  • The US equity market, represented by the S&P 500 index, rose 0.5% for the week ending October 13.
  • US Large Cap stocks are once again lapping the major equity asset class field in 2023. In recent years, expanding relative valuations explain some of the outperformance.

US large cap stocks are once again leading the way across equity asset classes in 2023. US large caps are dominated by the “Magnificent Seven” names representing the largest stocks by market capitalization (Apple, Microsoft, Alphabet, Amazon, NVIDIA, Tesla, and Meta). Those seven names accounted for 11.1% of the S&P 500’s 13.1% total return for the year through September.

Since the start of the year, US large caps are beating small cap stocks by over 10%. US large caps are also ahead of foreign developed markets by 4.5% for the year and are 9% ahead of emerging markets stocks.

Why bother with small cap stock allocations? Along with the well-known evidence supporting the “size” factor as a positive contributor to stock returns, valuations of small cap names are well below historic averages versus large caps. The last time small caps were so cheap relative to large caps was in the early 2000s, and small caps subsequently outperformed large caps for the next ten years.

Source: Russell Investments, September 30, 2023

What about international developed markets? There too, valuations have been aggressively stretched relative to US large cap stocks. JP Morgan Asset Management estimates that foreign stocks are trading at a 30.5% discount to US stocks.

Source: JP Morgan Asset Management, September 30, 2023

Valuations are not useful for timing one equity asset class’s performance versus another, but they do provide some evidence for long-term future returns. It is reasonable to expect US small caps and foreign developed markets to close the valuation gap with US large caps in the coming years – or at least for the divergence to stabilize. The macroeconomic drivers of profits and growth which have led to good performance from small caps and international developed market stocks in the past have not dramatically changed.

Emerging markets may be a different story. The drivers of emerging markets equity outperformance in the late 1990s and 2000s were the “Asian Tigers” export-led boom and China’s massive investment in its domestic economy. Those growth impulses may have changed in fundamental ways. That said, so much of the global population and expected economic growth are in emerging markets countries that fully excluding those names from portfolios makes little sense.  

The emergence of AI as a theme has been a boon to mega-cap tech names, most of which reside in US equity listings. It is also apparent that mega-cap tech has been able to extract recurring profits from the global economy in ways that have supported those valuations. Excluding other asset classes is tantamount to expecting this trend to continue indefinitely, historical evidence to the contrary.


IMPORTANT DISCLOSURES: All info contained herein is solely for general informational purposes. It does not take into account all the circumstances of each investor and is not to be construed as legal, accounting, investment, or other professional advice. The author(s) and publisher, accordingly, assume no liability whatsoever in connection with the use of this material or action taken in reliance thereon. All reasonable efforts have been made to ensure this material is correct at the time of publication.  Copyright Indiana Trust Wealth Management 2023.