Moat Stocks Gain as Mega-Caps Falter

July saw a notable shift in U.S. equities. The Magnificent 7 tech sell-off drove a divergence between mega-cap growth stocks and the more value-oriented and smaller large-cap segment of the market. Nvidia and the rest of the Mag 7 have led the market for much of the year, and their sharp declines in July pulled down the broader market indexes. Meanwhile, small-caps and value-oriented areas of the market saw significant gains during the same period. While this rotation out of the mega-caps has only recently emerged, this trend may just have legs as many investors now appear to be looking for ways to reduce their exposure to the historic levels of concentration in equity markets today.

The Morningstar Wide Moat Focus Index (the “Moat Index”) significantly outperformed in July, gaining 5.44% versus the 1.22% return for the S&P 500 Index. Driving this outperformance was an underweight to mega-cap tech, as well as strong stock selection, particularly within the industrials sector. More on drivers of performance are below. Year-to-date, the Moat Index remains a laggard to S&P 500, given its value bias and structural underweight to mega-caps, but this contrarian positioning may prove favorable going forward as market dynamics shift.

After months of struggle, U.S. smaller cap stocks staged a remarkable turnaround in July, with the pure small-cap benchmark rising over 10% and the mid-cap benchmark up nearly 6%. A strong consumer price index (CPI) release on July 11 was a primary catalyst for this rally in smaller names. The CPI report showed further easing in inflation, increasing the market-implied odds of a September rate cut by the U.S. Federal Reserve. The Morningstar US Small-Mid Cap Moat Focus Index (the “SMID Moat Index”) trailed pure small-caps, but slightly outpaced mid-caps in July.

Moat Stocks Rebound in July

The Beginning of a Magnificent Rotation?

Much of this year has been characterized by extreme levels of concentration within the U.S. equity market, driven by the Magnificent 7 and the mania around AI. Over the last few weeks, Nvidia and mega-cap tech have stumbled in what could be characterized as the start of a “Magnificent Rotation.” Stretched valuations and questions around when the massive capital expenditures in AI will begin to deliver a return have led investors to take some chips off the table and rotate into more value-oriented areas of the market.

Since Nvidia’s mid-June all-time high, it has fallen roughly 20% through the beginning of August, dragging down the broader market, while the Moat Index gained over 5% during the same period. The Moat Index benefited from its focus on high quality companies with attractive valuations, which has guided it toward a slight value bias and pushed it away from mega-cap tech. The Moat Index’s positioning has been a headwind for much of 2024, but may now prove beneficial considering current market dynamics. Further illustrating the rotation away from the Mag 7, the equal weighted variant of the S&P 500 index was also up during the period; however, its low-conviction methodology that indiscriminately allocates equally to all 500 constituents lagged the Moat Index.

Moat Index Rebounds on Rotation Away from Mega-Caps

Moat Index Highlights: Notable Stock Selection

Beyond the underweight to mega-cap tech, strong stock selection within the strategy was also a notable driver of relative performance in July. Selection effect during the month accounted for over 300 basis points of outperformance versus the S&P 500. The majority of that is attributable to Industrial names, which are heavily featured in the top contributors table this month.

Consumer credit bureaus TransUnion (TRU) and Equifax (EFX) were both top contributors to performance during the month off the back of strong second quarter earnings results that sent shares of TRU and EFX up 21% and 15%, respectively. On TransUnion, Morningstar equity analyst Rajiv Bhatia maintained his $100 fair value estimate, noting that he continues to view the risk/reward profile on TRU shares as attractive. Other top contributors within Industrials include aerospace and defense manufacturer RTX as well as residential and commercial security products company Allegion (ALLE), which were each up over 15% in July.

Names detracting from the Moat Index this month were largely within the Technology sector, with the semiconductor industrial automation equipment provider Teradyne Inc. (TER) and the well-known mega-cap tech conglomerate Alphabet (GOOGL) both as top detractors. Other detractors include Charles Schwab (SCHW), global beauty products seller Estee Lauder (EL) and drug manufacturer Biogen (BIIB).

Top Contributors and Detractors from Moat Index - July 2024

Leading Contributors

Leading Detractors

SMID Moat Index Highlights: Morningstar Raises Allegion Fair Value Estimate

The smaller cap SMID Moat Index also benefited from the above-mentioned TransUnion (TRU) as the mid-cap stock’s July performance led the pack of SMID moat companies as well. Regional automobile dealership Asbury Automotive Group (ABG) was also a top contributor as shares rose over 18% in anticipation of its early August quarter earnings report. Another top contributor was Allegion (ALLE), a global leader in security products and solutions, which saw its share price spike following a strong earnings report. Morningstar’s Brian Bernard noted that wide-moat Allegion’s second quarter financial performance came in ahead of expectations with increased forward guidance as well. Brain raised his fair value estimate to $151 per share due to a more optimistic near-term revenue growth profit margin outlook.

Names that most negatively contributed to the SMID Moat Index performance during the month include internet content and e-commerce platform Pinterest (PINS), North America’s second-largest ride-sharing service provider Lyft (LYFT), packed food company Lamb Weston (LW), the largest global cruise company Carnival (CCL), and independent broker/dealer LPL Financial (LPLA), which all declined by double digits in July.

Top Contributors and Detractors from SMID Moat Index - July 2024

Leading Contributors

Leading Detractors

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 US moat companies:

VanEck Morningstar Wide Moat 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 characteristics.

VanEck Morningstar Wide Moat Value ETF (MVAL): wide moat companies within Morningstar’s value characteristics.