[Global Focus] Why Wall Street Is Betting on US Value Stocks Overshadowed by the Magnificent 7

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"This year's theme will shift from mega-cap growth stocks to cyclical value stocks." (Barry Bannister, Stifel Chief Equity Strategist)

Despite concerns about economic recession due to high interest rates last year, the New York Stock Exchange saw significant gains mainly in the Magnificent 7 stocks (Apple, Microsoft, Google Alphabet, Amazon, Nvidia, Meta, Tesla). Since this year is expected to be when the Federal Reserve (Fed) begins a full-scale rate cut, there is much optimism that investment will flow into risky assets like stocks.

Wall Street experts advise paying attention to value stocks as much as growth stocks this year. Last year, value stocks were overshadowed by the Magnificent 7 stocks fueled by the artificial intelligence (AI) boom and did not shine much. This year, with inflation expected to remain at a certain level and economic growth continuing, value stocks are anticipated to benefit. If the Fed delays the first rate cut later than March, contrary to market expectations, value stocks may experience less correction than growth stocks, making them useful as a hedge (risk avoidance) strategy. Undervalued value stocks are largely found among mid-cap stocks, with sectors such as banking and energy mainly highlighted.

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◆Focus on Mid-Cap Stocks This Year: "Good Time to Buy"= On Wall Street, there is an analysis that mid-cap companies, which had the smallest gains last year, are at a good buying point. Mid-cap stocks are characterized by higher stability than small caps and greater growth potential than large caps. Companies with a market capitalization between $2 billion and $10 billion are generally classified as mid-cap. Last year, mid-cap stocks lagged behind small and large caps in the New York Stock Exchange. While the S&P 500 index (composed of large-cap companies) and the Russell 2000 index (small-cap companies) rose 24.2% and 15.1% respectively, the S&P MidCap index, which includes mid-cap companies, only increased by 14.5%.

Jack Ablin, Chief Investment Officer at Cresset Capital, said, "Mid-cap companies benefit more from rate cuts in terms of funding and refinancing compared to large-cap companies," adding, "This is an attractive factor for investing in mid-cap companies."

Michael Sheldon, Executive Director at asset management firm HighTower RDM Financial Group, emphasizes that mid-cap stocks are undervalued based on price-to-earnings (P/E) ratios. According to Sheldon, from January 1997 to October 2023, the average P/E ratio of the S&P 400 was 1.04 times that of the S&P 500. However, the current ratio is only 0.68 times that of the S&P 500. This suggests that mid-cap stocks were overlooked when large-cap stocks overheated due to early anticipation of rate cuts starting from late October.

Representative exchange-traded funds (ETFs) investing in mid-cap stocks include iShares Russell Mid-Cap ETF (IWR) and Vanguard Mid-Cap ETF (VO). The Touchstone Mid-Cap Fund (TMAPX), a mutual fund that has outperformed the Morningstar Mid-Cap Index over the past five years, is also gaining attention on Wall Street.

◆Bank Stocks Expected to Rebound with Rate Cuts= Among value stock sectors expected to perform well this year, banking stands out. Last year, the S&P 500 Financials sector (SPSY), composed of banking stocks, fell sharply due to the chain reaction triggered by the March collapse of Silicon Valley Bank (SVB), but narrowly escaped disaster. From late October, when the Fed's pivot (direction change) movement spread, the sector rose 9.5%. Considering the S&P 500 rose 24% during the same period, the increase was not very large.

With concerns about U.S. banks alleviated by the Fed's rate cuts, it is expected that net interest income will increase this year, leading to a significant improvement in profitability.

Asset management firm DWS maintained an overweight position on large banks such as JPMorgan Chase, Bank of America, and Wells Fargo due to their solid profitability. KBW highlighted KeyCorp, Webster Financial, and Goldman Sachs. Particularly, Goldman Sachs has mostly divested its weakening consumer business segment, creating an environment focused on its core investment banking (IB) operations.

Additionally, regional bank stocks, which plunged due to unrealized losses from the sharp rise in bond yields last year, are expected to have significant upside potential. The SPDR S&P Regional Banking ETF (KRE) is an ETF related to regional banks.

◆U.S. Energy Companies Expanding Market Dominance "Attractive"= U.S. energy companies expanding their market dominance are also considered attractive. The U.S. became the largest liquefied natural gas (LNG) exporter last year, and crude oil production is expected to reach record highs over the next two years.

Moreover, ongoing mergers and acquisitions (M&A) among energy companies may place them in a favorable position regarding energy prices. Chesapeake, a natural gas company, became the largest U.S. natural gas company by acquiring Southwestern for $7.4 billion on the 11th (local time). Mark Viviano, Managing Partner at private equity firm Kimmeridge Energy Management, said, "Institutional investors tend to avoid mid-sized energy companies," adding, "If M&A increases company size, inclusion in the S&P 500 and reaching investment grade could drive significant stock price gains."

Major oil companies are attempting a superior strategy in market supply control by acquiring smaller competitors. ExxonMobil, which acquired shale company Pioneer for about $60 billion, and Chevron, which acquired oil exploration company Hess for $53 billion, are representative examples. The renewed rise in oil prices, which had been stagnant amid Middle East tensions, suggests potential improvement in refining margins.

Wall Street experts also recommend other value stock sectors such as industrials, food, and real estate. Dave Sekera, Morningstar's Senior U.S. Market Strategist, cited BorgWarner, an auto parts supplier; Campbell Soup, a food company; and Healthpeak Properties, a healthcare real estate investment trust.

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