The year 2024 has been a remarkable one for the stock market. Positive growth momentum, an unprecedented wave of technological innovation, and the election of a pro-business administration in the United States have fueled optimism. These factors suggest the possibility of an overextended market cycle, potentially leading to stretched valuations across many sectors. This pattern is not new; similar dynamics unfolded in the past, most recently during the era of monetary stimulus and the surge in COVID-related stocks.
This raises a critical question for investors: Should we lock in gains and step aside, or should we embrace the risk of following market momentum?
The prudent approach is to lean toward caution and emphasize fundamentals, which will become increasingly important as market inflows inevitably taper. Rigorous bottom-up analysis is essential, as the nuances in individual company performance often reveal the true risks.
An analysis of the top 1,300 U.S. stocks reveals significant dispersion in returns and fundamentals, particularly among small-cap stocks, which have experienced robust rallies. This distribution, characterized by "fat tails," indicates elevated risk. At the positive end of the spectrum, small-cap tech stocks have outperformed significantly, while many small-cap healthcare stocks populate the lower end with sharply negative returns.
The accompanying charts illustrate these dynamics. The first two charts present the distribution of returns and associated risks for U.S. equities, while the third chart highlights an aggregate downgrade in analyst ratings across all sectors. This trend underscores a cautious sentiment, even amid strong market performance.
Distribution of 1-month returns for US equities
Source: Investment Analytics
Distribution of low-risk score for US equities (higher is safer)
Source: Investment Analytics
Average rating changes per company in each sector - All sectors have experienced downgrades by analysts in the past month
Source: Investment Analytics
What do detailed facts tell us?
A deeper examination of company characteristics across sectors reveals a narrative consistent with the earlier charts: pockets of value are scarce, with opportunities primarily concentrated in select individual stocks. Among these, a few high-quality, high-growth small-cap companies that gained prominence during the COVID era have made significant strides in profitability, earning investor favor. However, relying on this subset to sustain a broad rally in small-cap U.S. stocks remains a speculative proposition.
The charts below provide concrete evidence of the current market dynamics, offering a data-driven perspective on the state of US Stocks.
1-month performance by sector - Small-cap materials, communication services, defensives, financial services & tech performed last month
Source: Investment Analytics
Growth in small caps is not better than that of larger companies, at least so far.....
Source: Investment Analytics
Valuations appear slightly more favorable for small caps in many sectors, yet a strong liquidity discount should be applied
Source: Investment Analytics
Low-risk scores for small caps are significantly lower than that of larger companies
Source: Investment Analytics
Our momentum scores don't show a consistent advantage of small-cap stocks.
Source: Investment Analytics
Detailed of November's average stock re-rating per sub-sector paints a grim outlook
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