Market Shift Predicted: From Mega-Cap Tech to Value and Mid-Caps in 2025
The year 2023 witnessed a remarkable surge in mega-cap tech growth stocks, propelling major market indices to significant gains. However, Neil Hennessy, chairman and chief market strategist of Hennessy Funds, predicts a shift in market dynamics in 2025. He anticipates a move away from growth stocks towards value investing and stock picking, particularly in small- and mid-cap companies. Hennessy believes that current market valuations, driven by the dominance of tech giants like Nvidia, are unsustainable and likely to create volatility in the coming year.
The Dow Jones Industrial Average and the S&P 500 Index, currently boasting trailing price-to-earnings (P/E) ratios of 27 and 24 respectively, are heavily influenced by the performance of these tech behemoths. The year-to-date returns of these indices, as well as the Nasdaq Composite, have been impressive, reaching 15.7%, 26%, and 31% respectively as of December 20, 2023, according to Morningstar. However, Hennessy cautions that this rapid expansion cannot be sustained indefinitely and will likely lead to market corrections.
Hennessy, also the chairman and chief executive of Hennessy Advisors, the parent company of Hennessy Funds, suggests that investors brace themselves for potential market fluctuations. He anticipates a shift towards value investing and emphasizes the potential of mid-cap stocks, defined as companies with market capitalizations between $1 billion and $10 billion. He argues that mid-caps are currently undervalued, trading at approximately 18 times forward earnings, compared to their large-cap counterparts.
Mid-cap companies offer several advantages, including diversification across multiple business lines, greater agility compared to larger corporations, and strong performance potential with lower volatility compared to small-cap stocks. Hennessy highlights the historical outperformance of mid-caps over large-caps in the long run, suggesting that they could experience a surge as large-cap stocks face increasing volatility.
Economic Outlook and Investment Strategies for 2025
Hennessy Funds projects a stable economic environment in 2025, with inflation remaining under control and interest rates holding steady. This scenario is expected to neither significantly benefit nor hinder businesses and consumers. Consumer spending is predicted to remain robust, supported by low unemployment, strong job openings, healthy corporate profits, and positive cash flows. While the holiday season may experience a slight slowdown, overall consumer resilience is expected to prevail.
Dismissing widespread market euphoria outside of specific sectors like AI and cryptocurrencies, Hennessy advises investors to prioritize diversification and strategic stock picking. He believes that U.S. equities offer a moderate risk-reward profile, supported by a positive earnings outlook and ample cash reserves for stock buybacks and dividends. Furthermore, he points to the substantial amount of cash currently held by corporations, money market funds, and bank deposits as a potential catalyst for future market activity.
Hennessy anticipates a rotation into more defensive sectors, such as consumer discretionary, industrials, and utilities, if growth stocks experience a slowdown. He also expresses optimism for the financial sector, predicting strong performance driven by improving interest rates and a healthy banking system.
Highlighting the Success of Hennessy’s Mid-Cap Strategy
Hennessy showcases the Hennessy Cornerstone Mid Cap 30 Fund (HFMDX) as a prime example of successful stock picking in the mid-cap space. This fund, boasting impressive returns of 30.8% in 2023 and year-to-date returns of 36.3% as per Morningstar data, has consistently outperformed the S&P 500 over various timeframes (1-year, 3-year, 5-year, and 10-year periods). The fund achieved the top 1% ranking within its category at the end of the third quarter.
The fund’s concentrated portfolio of 30 stocks focuses on mid-cap companies and employs a strategy that combines value investing, earnings momentum, and stock momentum. With a significant allocation to consumer discretionary and industrials, the fund maintains a lower valuation compared to the broader market, as evidenced by its price-to-sales ratio of 0.9 versus the Russell Midcap Index’s 1.8 and a forward P/E ratio of 12.6. In recognition of its strong performance, the fund was awarded the 2024 Refinitiv Lipper Fund Award for Best-in-Category performance over a five-year period, outperforming 826 other funds. The fund carries an expense ratio of 1.34%. This fund’s success serves as a compelling argument for considering mid-cap investments in the evolving market landscape.
