Fidelity: U.S. small and mid-cap stocks may benefit from market expansion, with positive valuation and earnings outlook

According to the Zhitong Finance APP, Chris Wong, a portfolio strategist at Fidelity, stated that as of mid-year, the market has been dominated by large-cap stocks for the past two years, with market breadth below long-term averages. Although the market rally has since broadened, if the market lifecycle continues to develop as expected, breadth still has the opportunity to expand further. Considering the high weight of the "seven major tech stocks" in the S&P 500 index, the popularity of index funds may have contributed to a certain degree of market concentration. Investors are relatively light on small and mid-cap stocks, so small and mid-cap stocks may benefit from market expansion.

Additionally, when the Federal Reserve begins to cut interest rates, the stock market often performs well. With the rate-cutting cycle already underway, this means that stock prices may continue to strengthen. In a declining interest rate environment, sectors outside of large-cap growth stocks may perform better, such as value stocks and non-large-cap stocks.

Valuation and Earnings Outlook for Small and Mid-Cap Stocks Are Positive

Chris Wong noted that the valuation gap between small and mid-cap stocks and large-cap stocks has narrowed, even falling below long-term historical averages. There is room for the valuation of small and mid-cap stocks to rise, with the potential to catch up to large-cap stocks. One of the challenges facing small and mid-cap stocks (especially small-cap stocks) is the upcoming "debt maturity wave" over the next five years. However, as the rate-cutting cycle becomes more certain, small and mid-cap stocks will be able to refinance their debts. This will help alleviate expenses and enhance profitability.

Investors May Seek Opportunities Outside the U.S. Market

The strong performance of the seven major tech stocks in the past has led some investors to become overly concentrated in the U.S., growth stocks, and large-cap stocks. Therefore, exploring other opportunities in global markets may effectively diversify risk. Additionally, considering that the fundamental factors in Europe are resilient and central banks have begun to cut interest rates, the current valuations of major consumer goods stocks in Europe are more attractive than their U.S. counterparts.

It is worth emphasizing that Europe has many attractive companies, many of which have businesses that span the globe. Furthermore, the revenues of these companies often come from various sources, making them an excellent avenue for investment in expanding markets such as India and China. Meanwhile, the outlook for the UK stock market is healthier than in previous years. In addition to being undervalued, the combination of growth and income stocks in the UK stock market offers many choices for investors.

Moreover, investors have overlooked Asia for some time. However, earnings growth in Asia is strong, and regional stocks are expected to be supported by various structural trends, including moderate inflation in Asia, which implies room for interest rate cuts. This is supported by fundamental factors, including lower corporate and consumer borrowing, healthier current account surpluses, ample foreign exchange reserves, and less dollar-denominated debt.

China has shown initial signs of recovery, particularly in areas such as exports and manufacturing. Recent easing measures by authorities may further support this recovery. Additionally, Chinese companies are gradually announcing plans to increase dividends and buy back shares, placing greater emphasis on shareholder returns.

Another potential factor driving the expansion of market breadth is earnings. Non-large-cap stocks have recently shown strong earnings performance, with many companies expected to achieve their first profit growth since the fourth quarter of 2022. In contrast, the earnings growth rate of large-cap stocks has declined compared to previous high-growth periods Diverse Investment Opportunities Have Arrived

Although technology stocks have been highly sought after in the past two years, there are still parts of the global technology sector that investors should not overlook. The recent upward trend has primarily been driven by a group of large-cap stocks focused on artificial intelligence (AI), overshadowing numerous industries in the tech market that may present opportunities.

Within the AI value chain, data infrastructure and IT consulting companies are crucial components but are often underestimated. Investors have also undervalued the long-term potential of software companies monetizing AI capabilities.

The market has become overly obsessed with large tech stocks, leading to the neglect of small and mid-cap tech stocks, making some of these smaller stocks potential acquisition targets. Some traditional industries (such as industrials) are leveraging technology to enhance internal operations and serve customers. However, the market has yet to consider these technology-driven transformations, presenting diverse investment opportunities for investors.

Considering all the above factors, areas outside of large-cap stocks offer substantial value for investors. Small and mid-sized enterprises around the world are positioned to benefit from a rate-cutting cycle. Dividend stocks are also supported by robust earnings and valuations, expected to provide sustainable and inflation-resistant total returns, not only in U.S. dividend stocks but also in European, British, and Asian dividend stocks. Even within sought-after sectors like technology stocks, opportunities exist beyond popular themes and large-cap stocks.

Peter Lynch, former fund manager at Fidelity Investments, stated that when investing in the stock market, investors should diversify their investments, holding different types of funds and investing in various styles of stocks, such as growth stocks and value stocks, as well as small-cap and large-cap stocks.

Growth stocks and the U.S. stock market have become overly concentrated. While continuing to capitalize on market growth, investors can also consider diversifying their investments across different regions, industries, and a broader range of stock sectors to manage risks in a potentially uncertain environment