But it’s starting to look very expensive, and that should be a red flag for investors.
The S&P 500 – the main benchmark for the US stock market – has delivered an annualised return of 13.1% over the past decade. That means a £10,000 investment would now be worth somewhere in the region of £37,000. This puts it way ahead of most of its peers.
The problem is that no investment trend lasts forever. Markets often have long periods where they favour specific areas – commodities in the 2000s, for example, or internet stocks in the 1990s – but the fallout can be painful when sentiment reverses and investors need to be alert to signs of a shift.
For the US stock market, cracks are starting to appear. The market is now concentrated in just a handful of stocks, and in a single sector (technology). The top 10 stocks in the S&P 500 now make up 34% of its market capitalisation – the highest concentration ever.
These top 10 stocks look highly valued. The price-to-earnings ratio for Apple (a measure of a company’s valuation relative to its earnings) has expanded by around a third over the past year alone. While stocks such as Nvidia continue to deliver strong growth, the price investors need to pay for that growth has increased significantly.
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Can US dominance continue?
Hugh Grieves, manager of the Premier Miton US Opportunities Fund, believes that the US market still has much to offer investors, saying: “The US has been a strong performer. It’s been attracting more and more capital and people have very high allocations to the US. This is a huge contrast to 20 years ago, even 10 years ago.”
He doesn’t see this trend reversing, even though the election of Donald Trump may bring some volatility. He points out that the US economy looks pretty healthy compared to the rest of the world – “a shining light of growth and health compared to other markets”.
However, he believes the real value lies outside the technology giants from here, and is avoiding them in his fund. The rest of the market holds great potential, he says, with consumer confidence a tailwind, and the potential for consumers to take on additional debt if necessary.
The housing market may pick up, having been lacklustre in recent years. That has a potential multiplier effect. Manufacturing could also pick up, particularly if investment restarts after a hiatus during the election, he says.
Where should investors be looking to harness this potential? The team on the T. Rowe Price US Smaller Companies Equity Fund says: “We see a broadening opportunity set in US equity markets, spanning several sectors. Small caps, which are trading at a historic discount to large caps, should benefit from further rate cuts and any signs of an improving economy.
“In addition, the current position of the energy cost curve indicates that we could be in for a multi-year regime change of capex and investment spend in energy, which would also benefit small-cap stocks.
“From a sector perspective, financials look interesting. After Fed rate increases led to such poor performance for banks and real estate investment trusts in 2024, the market is anticipating better performance for this rate-sensitive group should rate cuts continue into 2025.”
The team also sees a number of software firms that were not immediate beneficiaries of AI. These have strong earnings growth prospects and are more attractively valued than their fashionable large cap peers. Utilities may also be an overlooked beneficiary of AI in the year ahead.
What about income stocks?
Michael Rossi, co-manager of the JPM Global Equity Income Fund, believes investors should look more closely at dividend-paying companies. These have been out of the spotlight, with many technology companies only starting to pay (small) dividends over the past few years.
He says: “Dividend payout ratios are now close to 25-year lows. In other words, companies are underpaying relative to history. Just returning back to a more normal level of payout provides an additional 2% year of growth over five years. This isn’t just hypothetical; the payout recovery story is already starting to play out, with global dividend growth outpacing earnings growth in seven of the last eight quarters.”
This has the extra advantage of helping protect investors against inflation – which remains a real risk in the year ahead. Trump’s agenda of tax cuts, tariffs and deregulation is inherently inflationary.
This is also a cheaper part of the market. Michael adds: “Market concentration and AI hype have resulted in unusually depressed relative valuations levels for the dividend-paying stocks.
“This presents investors with an opportunity to enter an attractive long-term trend to capture income and growth by exposing themselves to companies with strong business models and steadily growing dividends.”
It may also prove defensive should the Trump agenda ultimately send stock markets awry.
There is no need to abandon the US market. It has shown itself to be a good home for investments over the years. However, it may be worth taking more diversified exposure, including smaller companies, or dividend stocks, alongside the all-powerful technology companies.
Darius McDermott is managing director of FundCalibre and Chelsea Financial Services
