Moat Stocks Steady Amid Tech’s Market Surge
09 July 2024
Read Time 6 MIN
U.S. equities climbed higher in June as the S&P 500 posted its seventh positive month out of the last eight. The broad market index rose more than 3% during the month to cap off what has been a strong first half of 2024. Notably though, and characteristic of what we have seen all year, June’s gains were once again top-heavy, with just a handful of mega-cap tech names driving the majority of market performance. The Magnificent 7 (NVIDIA, Microsoft, Apple, Google, Tesla, Meta and Amazon) make up about 30% of the S&P 500 and have accounted for 60% of the index’s performance so far this year. Further illustrating this lopsided market is the equal-weighted S&P 500, which was down half a percent in June and is trailing the market cap-weighted variant by 10 percentage points year to date.
The Morningstar Wide Moat Focus Index (the “Moat Index”) finished flat during June, trailing the broader market but finishing ahead of the equal-weight S&P 500 Index. Driving underperformance was the Moat Index’s current value bias and structural underweight to the Magnificent 7, which comprises only 4.5% of the Moat Index by way of Alphabet, Amazon and Microsoft. The Index’s differentiated exposure, while susceptible to periods of underperformance at times, has historically provided impressive long-term performance and can serve as a useful diversifier away from the concentration risk present in today’s market.
Companies on the smaller end of the market cap spectrum were notable laggards in June, with small- and mid-cap benchmarks down 2.38% and 1.58% during the month, respectively. The Morningstar U.S. Small-Mid Cap Moat Focus Index (the “SMID Moat Index”) fared slightly better, down only 98 basis points during the month. The higher for longer interest rate regime has weighed on small-cap performance so far this year, but the expected commencement of easier monetary policy in the second half of the year may put some wind at the back of this cohort.
Mega-cap Tech Dominated Indexes Lead at the Half | As of 6/30/2024
Source: Morningstar. As of 6/30/2024. Past performance is no guarantee of future results. Index performance is not representative of fund performance. It is not possible to invest directly in an index. Fund performance current to the most recent month end is available by visiting vaneck.com or by calling 800.826.2333.
Moat Index Quarterly Review Highlights: Staying the Course as Valuations Lead the Way
Both the Moat and SMID Moat Indexes underwent quarterly reviews on June 21, 2024. Each quarter they systematically target the most attractively priced, high quality U.S. companies within their respective universes. Below are a few takeaways from the reviews and how the indexes are now positioned. Full results of the most recent quarterly reviews are available here: Moat Index and SMID Moat Index.
Additionally, in our recent moat investing webinar, we provided more information on current positioning and recent performance, and members of Morningstar’s equity research team shared their perspectives on market trends and the companies they cover. View the webinar replay here: Are Semiconductor Moats Worth the Price?
The Moat Index entered 2024 with a contrarian bias toward large cap stocks (as opposed to the mega caps that dominate the S&P 500 Index) and a very slight value posture. That bias has remained through the first two quarterly reviews of the year. The Moat Index remains notably underweight growth stocks relative to the S&P 500, with core stocks that exhibit characteristics of both growth and value making up much of the difference. The recent exposure has reflected the valuation opportunities in the U.S. market among high quality, wide moat companies as the Index’s systematic, rules-based process avoids the tendency to follow the crowd.
From a sector perspective, Financials exposure was reduced on the heels of a strong quarter (or strong several quarters in some cases) from banks. Allocations to Bank of America, Bank of New York Mellon, Charles Schwab and Wells Fargo were all removed or reduced. Offsetting the reduced Financials exposure were increases to areas like Consumer Staples, Industrials and Technology. Despite the increase in technology names, which came by way of software companies like Adobe, Autodesk and Fortinet, the sector still sits at a notable 14% underweight relative to the S&P 500.
Moat Index Sector Shifts Following 2Q 2024 Review
Source: Morningstar. As of 6/21/2024. Index performance is not representative of fund performance. It is not possible to invest directly in an index.
U.S. Equity Exposure Without the Lofty Valuations
The price/fair value ratio of the S&P 500 Index currently sits at 1.05. This implies that the companies in the S&P 500 are, overall, trading at approximately a 5% premium, according to Morningstar. This presents a challenge for investors looking to deploy cash into U.S. markets that have already appreciated by more than 15% this year. The Moat Index represents high quality companies currently mispriced by the market, in Morningstar’s view. It allows investors to consider a mix of well-positioned companies with upside potential. Currently, the Morningstar price/fair value ratio of the Moat Index is 0.81, implying a 19% discount to fair value.
SMID Moat Index Highlights: Materials and Utilities Replace Expensive Tech
In the latest quarterly update, the shift in the SMID Moat Index saw a notable reallocation from expensive technology stocks to more traditional sectors like Materials and Utilities. Technology stocks experienced the most substantial sector change, decreasing by 3.9%, with nine companies, of which five were semiconductor companies, exiting the index. As a result, technology's representation in the index has reduced to 12%, which is slightly below the sector's weight in the Russell 2500 index.
Conversely, the Materials and Utilities sectors witnessed increases, rising by 2.2% and 1.5% respectively. New additions to the index include prominent companies like Scots Miracle-Gro, Corteva, WEC Energy, and Portland General Electric, among others. Following these additions, Materials and Utilities now represent 9% and 7% of the index, positioning them as overweights when compared to their presence in the Russell 2500. At the industry level, Electric Utilities have emerged as the largest overweight, contrasting with Regional Banks and Biotech, which are now the most significant underweights.
SMID Moat Index Sector Shifts Following 2Q 2024 Review
Source: Morningstar. As of 6/21/2024. Index performance is not representative of fund performance. It is not possible to invest directly in an index.
Valuation Opportunity within SMID Moats
The weighted average price-to-fair value of the SMID Moat Index fell from 0.83 to 0.80 following the June review, signaling a 20% discount to Morningstar’s fair value estimate. The broad-based Russell 2500 Index featured fairly priced valuations with a weighted average price-to-fair value ratio of slightly over 1.00, as of the same date.
Choose Your Moat Strategy
VanEck’s suite of moat investing strategies is powered by Morningstar’s equity research team, which seeks quality companies trading at attractive valuations. The below ETFs offer access to U.S. moat companies:
VanEck Morningstar Wide ETF (MOAT): companies with a wide moat rating, which means Morningstar believes the company is likely to sustain its competitive advantage for at least the next 20 years.
VanEck Morningstar SMID Moat ETF (SMOT): small and mid-cap moat companies.
VanEck Morningstar Wide Moat Growth ETF (MGRO): wide moat companies within Morningstar’s growth style category.
VanEck Morningstar Wide Moat Value ETF (MVAL): wide moat companies within Morningstar’s value style category.
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