US Mid Caps just like their larger counterparts, endured significant losses over the course of 2022. The performance over the first three quarters between the two segments was very similar as US Equities in general suffered from higher rates and economic slowdown. However, as we entered the fourth quarter, the S&P® MidCap 400 Index began to outperform. While we are constructive on the US equities overall due to nearing peak rates and increasingly attractive valuations, there are several aspects of the Mid Cap segment which place it in a sweet spot.
Firstly, mid cap equities are more domestic than their larger counterparts, generating approximately three quarters1 of revenues from within the US. That makes the stronger US dollar less of a headwind in a year where the US currency measured by the DXY Index appreciated by 13%2. At the same time, despite the economic slowdown and the monetary tightening, the demand from US consumers remains robust as a relatively resilient labour market provides support.
When it comes to investing in US Equities the key concern for investors remains the high US risk-free rate which is diluting equity risk premia. However, for the S&P MidCap 400 Index, higher rates as well as remaining hikes from the Fed appear to be already priced in, as the valuation sits at an undemanding 12m forward P/E of 13.7x3 which translates to a 7.3% earnings yield and a 3.4% spread over 5 year US treasuries. This is important consideration as mid cap equities are not only attractively priced relative to larger companies but also offer a decent yield premium to fixed income instruments.
The next question mark for US Equities is in earnings and risk of downgrades. In case of Mid Caps the earnings component in the above-mentioned P/E does not appear be overstated as Q3 earnings surprised to the upside by 6.6%, a number that is higher than the same ratio for both large caps (+3.0%) and small caps (+2.9%)4. In general, Q3 earnings has largely been a revenge of the old economy and resilient profits of the Mid Cap segment fit into that theme as the strategy offers access to more traditional businesses.
We acknowledge that the sector split of the S&P® MidCap 400 Index is relatively cyclical and the global economy is still facing multiple challenges. Nevertheless, the resilient earnings, domestic profile and attractive valuation makes us particularly constructive on the Mid Cap part of the US Equity market. As the Fed is nearing peak rates investors may start positioning their portfolios for what lies beyond. This is even more the case if we consider most recent CPI print of 7.7% which is a long awaited evidence of moderation in inflation.
S&P® MidCap 400 Index 12m forward Price to Earnings
Source: Bloomberg Finance L.P., State Street Global Advisors as of 9 November 2022. Price to Earnings is 12m forward Bloomberg BEST_PE_RATIO of SP400NTR Index.
1 Source: FactSet, State Street Global Advisors as of 30 September 2022
2 Source: Bloomberg Finance L.P. as of 10 November 2022. Year to date number.
3 Source: Bloomberg Finance L.P., State Street Global Advisors as of 10 November 2022.
4 Source: Bloomberg Finance L.P. as of 10 November 2022, based on 90% of S&P MidCap 400 Index, 92% of S&P 500 Index and 90% of S&P 600 Small Cap Index constituents which reported to date
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