After this year’s tremendous runup in mega-cap tech growth stocks, next year the market will probably see a shift to value and mid-cap stocks predicted Neil Hennessy, chairman and chief market strategist of Hennessy Funds, at the company’s recent market outlook press conference.
The Dow Jones Industrial Average, with a trailing price-to-earnings (P/E) ratio of 27, and the S&P 500 Index’s P/E at 24, are both distorted by tech stocks, such as Nvidia (NVDA). The year-to-date returns of the Dow, the S&P 500, and the Nasdaq Composite are 15.7%, 26%, and 31% respectively, as of Dec. 20, according to Morningstar. This rapid expansion is unsustainable and will create volatility in the indexes.
“People are going to end up being very disappointed with the indexes or they’re going to enjoy the roller coaster ride because it’s going to be all over the place,” said Hennessy, who is also the chairman and chief executive of Hennessy Advisors (HNNA), the funds’ parent company. Based in Novato, CA, the firm has 17 funds with $4.8 billion in assets under management.
He predicts 2025 will see the market shift from growth stocks to value investing and stock picking, especially in small- and mid-cap stocks. Mid-caps are companies with capitalizations between $1 billion and $10 billion. He likes mid-caps because they’re undervalued, at about 18x forward earnings, compared to companies with large-capitalizations. Mid-caps are also diversified, have multiple business lines, and are more nimble than large-caps. They also have strong performance potential with lower volatility compared to small-cap stocks. Over the long-term, mid-caps outperform large-caps, and could experience a surge as large-cap stocks face increased volatility, said Hennessy.
Economic and Inflation Outlook
For the broader economy, the firm forecasts inflation will remain under control, and interest rates will remain stagnant, neither helping nor hurting businesses or consumers. However, consumers are expected to be resilient, with consumer spending expected to stay robust despite projections of a slower holiday season. Other positive factors include low unemployment, strong job openings, as well as, healthy corporate profits and cash flows.
The perennial market bull said that aside from AI and cryptocurrencies, there is not widespread euphoria in the market, and that investors need to focus on diversification and stock picking.
Going forward, he thinks U.S. equities offer moderate risk for reward because of a positive outlook for earnings, and a lot of cash for stock buybacks and dividends.
Overall, there is still a lot of cash on the sidelines. As of Oct. 31, S&P 500 companies held $7.1 trillion on their balance sheets, according to Bloomberg. Money market funds held $7.0 trillion and bank deposits are at record highs of $17.3 trillion, according to the Federal Deposit Insurance Corporation (FDIC), and the Investment Company Institute (ICI), a fund company trade group.
He sees sector rotation into more defensive sectors —consumer discretionary, industrials, and utilities) if the growth stocks slowdown. Financial stocks are also expected to do well on improving interest rates and a healthy banking system.
An Award-Winning Mid-Cap Fund
Hennessy pointed to the stock-picking success of the firm’s Cornerstone Mid Cap 30 Fund (HFMDX) (up 30.8% last year and year-to-date returns of 36.3%, according to Morningstar,) as a way to capture returns without relying on the “Magnificent 7” tech stocks. The fund has outperformed the S&P 500 over 1-year, 3-year, 5-year, and 10-year periods, according to Morningstar, and received the firm’s 1% ranking as of the end of the third quarter.
The concentrated portfolio of just 30 stocks focuses on mid-cap stocks with a strategy of combining value investing, earnings momentum, and stock momentum. Consumer discretionary and industrials make up more than 50% of the fund. The fund has a lower valuation than the overall market with a price-to-sales ratio of 0.9 vs. the Russell Midcap Indexes’ 1.8 and a forward PE ratio of 12.6.
It won the 2024 Refinitiv Lipper Fund Award for Best-in-Category performance for the 5-year period, beating 826 funds. It charges an expense ratio of 1.34%.