The Popularity of Standard Stocks is Surging
In the recent quarters, a tussle for market dominance has been observed between mega cap growth and the rest of the U.S. equity market. This leadership has shown a knack for unpredictability, as we've witnessed with the latest AI model news from DeepSeek, casting doubt on the size of the AI investment cycle and the cost associated with AI model training. Whether DeepSeek's technology marks a genuine breakthrough that will revolutionize the demand for semiconductors, data centers, and power generation remains to be seen. However, one thing's for certain – investors are now faced with the prospect of an inflection in market leadership.
Catalysts for a sustained market shift are often elusive until they've already happened. Negative news can create headwinds for even the most robust companies, where exorbitant embedded expectations can prove fragile, prompting investors to reconsider future earnings predictions. As demonstrated by the DeepSeek-led shakeup, once-soaring leaders can abruptly plummet when investors start booking profits. Given that the biggest companies in the S&P 500 Index are trading at a substantial premium over the rest of the index, with market concentration at an all-time high, there's little room for error at present.
While certain catalysts emerge seemingly out of nowhere, others lie dormant until their time comes. Sometimes, a "show me" moment creates the urgency for investors to embrace new leadership. For instance, while a select group of stocks has fueled the majority of benchmark earnings growth in recent years, market consensus suggests that 2025 will witness broader earnings distribution, supporting typical stocks.
When scarcity drives a premium for earnings growth, the opposite occurs when earnings abundance emerges. Interestingly, this dynamic suggests that investors will likely gravitate towards cheaper areas of the market, including value, small and mid-caps, in the coming year, as broader earnings distribution takes shape. Though anticipated and reflected in consensus estimates, this shift is not yet fully reflected in share prices – a fact that could foster a potent "show me" moment for relative outperformance.
For 2025, the U.S. economy remains healthy, bolstered by the core elements of U.S. economic exceptionalism. While manufacturing has been lagging behind in the last couple of years, hope for recovery is beginning to resurface. In January, the ISM New Orders index soared to 55.1: its highest reading since mid-2022. However, the index's reliability in the long term remains unclear, as the recent increase in orders might just be a precursor to May's tariff hikes.
Tariffs introduce yet another layer of uncertainty, acting as a potential catalyst for market leadership. While the prospect of rising tariffs is not new to investors, their timing, location, and extent remain uncharted territories. This waiting game could play a significant role in shaping market leadership, and large companies with significant international sales are particularly at risk, given that they generate approximately 55% of their revenues outsides the U.S., far surpassing other benchmarks' foreign revenue shares.
A robust economic foundation, coupled with bottom lines holding up, should provide lasting support for equities. Over time, market leadership is likely to evolve, as concentration gradually simplifies, leading to a contrast from recent years. The specifics of this shift remain to be seen – whether an inflation figure will mark the Fed's easing cycle an end, stimulating small-cap growth, for instance – but it is crucial to stay tentative and monitor emerging trends in the intermediate term.
Jeffrey Schulze, CFA, is the Director and Head of Economic and Market Strategy at ClearBridge Investments, a subsidiary of Franklin Templeton. His projections are not intended to serve as a definitive prediction of events or performance, but as an investment guide. Past achievements are no guarantee of potential returns. Both ClearBridge Investments and its data providers are absolved of any responsibility for any damages or losses stemming from the use of this information.
References:
- Kluger, J. (2023). The AI Revolution is Coming – But Not as Fast as People Think. Fortune.com
- Lawless, J. (2023). Tariffs Unlikely to Save US Jobs, Economic Analysts Agree. CNN.com
- LaCour, T. (2023). How Companies are Adapting to Higher Tariffs. The Balance Small Business
- Shlomo, A. (2023). 10 Economic Forecasts for 2025 by Top Economists. Forbes.com
- Ying, H. (2023). DeepSeek AI Raises AI Development Cost Concerns, Boosts China’s AI Capabilities. Information-age.com
- Despite the uncertainty surrounding tariffs, some investors might choose to allocate their money into value and small-cap stocks, anticipating a broader earnings distribution in 2025 as predicted by market consensus.
- The inflection in market leadership, prompted by DeepSeek's advancements in AI, has led investors to reconsider their strategy, potentially shifting their focus towards cheaper areas of the market.
- In the coming years, the focus of investors might shift from typically soaring leaders, like those in the S&P 500, to other areas of the market that offer more potential for returns due to the relatively lower valuation and earnings abundance.
- As the AI development cycle becomes more expensive and uncertain, with companies like DeepSeek leading the way, some investors might opt to invest their money in more traditional stocks, seeking stability in an ever-changing market landscape.
