With former mega cap tech leaders losing momentum and AI stocks, in particular, facing new challenges, the spotlight has shifted to traditional defensive sectors and value stocks, according to T. Rowe Price.
But while the shift indicates a departure from the growth-focused market, the investment landscape is more complex than a simple “growth stocks versus value stocks” equation.
T. Rowe Price’s Sam Ruiz told InvestorDaily that market momentum is driven by a small subset of mega cap tech giants, particularly the “Magnificent Seven”, rather than a broader growth-versus-value trend.
Therefore, he noted, it would not be correct to simply assume that “growth has outperformed value”. In reality it comes down to the Magnificent Seven “beating everything else”.
“When they win by so much and they’re so large in the index, they are all that matters,” Ruiz stressed.
“Given they are growth stocks, they drove growth outperformance and would be a very large per cent of growth’s outperformance.”
However, he explained that mega cap tech stocks face headwinds due to stretched valuations and the limitations posed by their market capitalisation, which can constrain future growth potential.
“That makes it much harder for their growth rate to be sustained at past levels and they will need to print strong growth,” he said.
According to Ruiz, for the mega tech stocks, massive revenues mean that even an additional $10 billion in revenue becomes less meaningful in percentage growth terms the larger they get.
He stressed that the market is less concerned about how many billions in revenue the firms add, and more focused on the percentage growth achieved.
Moreover, Ruiz said while there has been a lot of excitement about how new products could help generate additional profits, there are uncertainties regarding the demand for certain software applications.
“Nvidia is generating more profit because of GPU [Graphics Processing Unit] demand, and the hyperscalers are generating more profit from increased demand for cloud computing. But will the end software/applications actually see strong demand?
“That’s a big question and Microsoft is an example of where we don’t yet know if Copilot [their software] will attract sufficient subscription fees to make the investment worthwhile. This also means that valuations could become vulnerable to a lack of return on these investments.”
He noted that this is occurring against “an unusual backdrop” of a strong economy, coupled with interest rate cuts, suggesting that more rate-sensitive and cyclical sectors are likely to perform significantly better.
“Normally you get rate cuts due to a weak economy so don’t want to own risk/cyclicals. It appears we have rate cuts and a strong economy. That’s different and very rare. It could be very good for some cyclical companies benefiting from lower rates/costs and higher demand,” he said.
“So, if you have earning growth getting better outside of these concentrated growth stocks that generally means that the performance starts to be more balanced and broader.”
Small caps
Turning to small caps, Ruiz said there are a number of factors, such as lower interest rates and cost of capital, that could help drive their outperformance, but this market segment also needs to navigate a new landscape.
He also noted that small caps benefit from “Trump trade”, which refers to market expectations that assume it will be easier to do business with former president Donald Trump in power.
“When it comes to the US small caps – there is a bit of Trump trade that went through the market because if the odds of Trump winning are higher, people expect that he is going to run more the deregulation mandate,” he said.
“And one thing that Democrats have been known for is making it harder for companies to acquire other companies.”
However, Ruiz also said he believes it will be much harder for small caps to compete with larger companies going forward as generative AI becomes mainstream.
“We think that going forward the majority of the innovation is going to centre around generative AI, and the generative AI relies on big balance sheets, strong cash flows, and you need big data sets,” he said.
“But a lot of these small companies tend to be much newer companies, and they haven’t got their history or the money or the diversification, or the customer base to have these large data sets.”
He added that some “fantastic small caps” are in the healthcare and biotechnology sectors, but moving forward, large biotech companies may increasingly rely on generative AI for developing blockbuster drugs, potentially reducing their dependence on smaller firms.
