US large-cap stocks expensive; opportunities galore in mid, small-cap shares playing catch-up

After having surged manifold in the last year 2020, large-cap stocks in the United States are not exactly cheap. The NASDAQ index galloped a massive 45% in the calendar year 2020. Equity indices surged higher, helped by rapid policy steps from the Federal Reserve and US Congress. But the high valuation of large-cap stocks on Wall Street does not mean opportunities have run dry. Analysts at global investment bank Citigroup say that small and mid-caps are favoured in the region now.

Citi analysts are neutral on US large-cap equities. “Broad market valuations are no longer cheap (trailing 2020 PE of 27.8x), even when pricing in recovery from the COVID-19 shock. However, this is largely a function of the strong rally in technology-related shares,” a report by Citi said. In 2020, large-cap growth stocks helped investors with returns of 38.5% while small-cap growth stocks were at 34% and midcaps at 35%, according to a report by JP Morgan Asset Management.

In the current year, Citi analysts see governance challenges with likely political paralysis in the United States. “While these may not collapse the economy as we saw with the fall in March / April, setbacks are likely given that confidence in the markets is fragile,” they added. 

How to invest?

The most beaten-down COVID-19 cyclical industries were still 35% lower till the end of November of 2020, while the COVID-19 beneficiaries were up 45%, according to Citi. In 2021, COVID-19 cyclicals appear unusually attractive with a massive dispersion gap. “As vaccines and treatments grow, a rotation to such cyclicals is highly likely to play out as the eventual departure of COVID-19 could mean more significant recoveries in the most impacted industries,” they added.

On a broader horizon, the investment bank sees the digital disruption theme to be unstoppable. “Among “COVID-19 defensives” are video conferencing, media, home gaming and e-commerce firms that have seen growth boosted by the nature of the pandemic,” the report said. Healthcare in another bet that analysts at Citi find to be in the groove going forward. The rationale behind this is the growing population of old people across the globe. “As the population ages in the developed world, the spending habits of this cohort evolves, to the benefit of some companies, including healthcare. Citi analysts note that the healthcare sector has a consistent record of revenues and earnings growth through cycles, but it tends to underperform in the early years of new economic cycles,” they said.

Other assets classes that the report highs are Real Estate Investment Trusts (REIT), dividend yield equities, and new energy.