As former mega-cap tech leaders lose momentum and AI stocks, in particular, face new challenges, attention has shifted to traditional defensive sectors and value stocks, according to T .Rowe Price.
But while this shift signals a break from the growth-oriented market, the investing landscape is more complex than a simple “growth stocks versus value stocks” equation.
Therefore, he stressed, it would not be correct to simply assume that “growth has outperformed value.” What it really comes down to is that the Magnificent Seven “beat everything else.”
“When they win by this much and they are so high in the index, they are all that matters,” Ruiz stressed.
“Given that these are growth stocks, they have generated growth outperformance and would account for a very large percentage of the growth outperformance.”
However, he explained that large-cap technology stocks face headwinds due to high valuations and limits imposed by their market capitalization, which can limit future growth potential.
“This makes it much more difficult to maintain their growth rate at past levels and they will need to deliver strong growth,” he said.
According to Ruiz, for mega tech stocks, massive revenue means that even $10 billion in additional revenue becomes less significant in terms of percentage growth as it increases.
He emphasized that the market cares less about the number of billions in revenue generated by companies than about the percentage of growth achieved.
Additionally, Ruiz said that while there has been a lot of excitement about how new products could help drive additional profits, there is uncertainty about demand for certain software applications.
“Nvidia generates more profits thanks to the GPU [Graphics Processing Unit] demand, and hyperscalers are generating more profits from increased demand for cloud computing. But will the final software/applications actually see high demand?
“It’s a big question and Microsoft is an example of where we don’t yet know if Copilot [their software] will attract enough subscription fees to make the investment worth it. This also means that valuations could become vulnerable to a lack of returns on these investments.
He noted that this is happening against an “unusual backdrop” of a strong economy, coupled with interest rate cuts, suggesting that the more rate-sensitive and more cyclical sectors are likely to perform much better.
“Normally you get rate cuts due to a weak economy, so you don’t want to hold risky or cyclical securities. It looks like we have rate cuts and a strong economy. It’s different and very rare. This could be very beneficial for some cyclical companies who would benefit from lower rates/costs and stronger demand,” he said.
“So if earnings growth improves outside of these concentrated growth stocks, that generally means performance is starting to be more balanced and broader.”
Small caps
When it comes to small caps, Ruiz said there are a number of factors, such as falling interest rates and the cost of capital, that could contribute to their outperformance, but that this market segment must also adapt to a new landscape.
He also noted that small caps are benefiting from the “Trump trade,” which refers to market expectations that it will be easier to do business with former President Donald Trump in office.
“When it comes to U.S. small caps, there’s a little bit of Trump trading that has flowed through the market because if Trump’s chances of winning are higher, people expect him to perform more the deregulation mandate,” he said.
“And one thing Democrats are 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 as generative AI becomes mainstream.
“We think in the future the majority of innovation will be centered around generative AI, and generative AI relies on big balance sheets, strong cash flows, and you need big data sets ” he said.
“But a lot of these smaller companies tend to be much newer companies, and they don’t have the history, or the money, or the diversification, or the customer base to have these big data sets.”
He added that some “fantastic small caps” are in the healthcare and biotech sectors, but that in the future, large biotech companies may increasingly rely on generative AI to develop blockbuster drugs, potentially reducing their reliance on small businesses.
