Marketing Communication

Market Rotation Propels Moat Stocks

14 October 2024

Read Time 6 MIN

Brandon Rakszawski

Director of Product Management

Coulter Regal

CFA, Product manager

Moat stocks surged 12% in Q3 as investors rotated away from the Mag 7 and toward more value-oriented areas of the market.

In September, U.S. equity markets extended their gains, with the S&P 500 reaching new heights, buoyed by Federal Reserve Chair Jerome Powell’s signal of a more dovish stance on monetary policy. Powell's commitment to sustaining economic health through the start of rate adjustments fueled optimism, overshadowing geopolitical concerns. This environment saw a significant rotation into value stocks, particularly in undervalued sectors, as investors sought balance amid a backdrop of easing monetary policy and a resilient, yet cooling, labor market. September's performance capped a strong quarter, setting a positive tone for market expectations into year-end.

The Morningstar Wide Moat Focus Index (the “Moat Index”) finished up 1.8% in September, capping off what was a notably strong third quarter where the Index gained 12.1% compared to the S&P 500’s return of 5.8%. The broadening out of the market, away from the Magnificent 7 and toward more value-oriented areas, provided a strong tailwind during the quarter. Year-to-date, the Moat Index still has some ground to make versus the S&P 500, but falling interest rates and the potential continued rotation away from mega-caps may prove supportive in the final months of the year.

Companies on the smaller end of the market cap spectrum also gained in September, but to a lesser extent. The small- and mid-cap benchmarks were up 0.9% and 1.2% during the month, respectively. The Morningstar U.S. Small-Mid Cap Moat Focus Index (the “SMID Moat Index”) fared better however, benefiting from strong stock selection leading to a 2.3% gain in September. During the quarter, small- and mid-caps bounced with market participants keying in on attractive valuations relative to large-caps and economic conditions that remain stable as we head into the start of a rate cutting cycle.

Moat Stocks Surged in Third Quarter | As of 9/30/2024

Source: Morningstar. As of 30/09/2024. 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.

Moat Index Quarterly Review Highlights: Core Shift and Fresh Faces

Both the Moat and SMID Moat Indexes underwent quarterly reviews on September 20, 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.

During the September review, the Moat Index saw 14 stock positions change within the portfolio. This reshuffling resulted in a slight shift towards core/blend stocks. Despite the shift toward blend, the Moat Index’s value posture remains in effect as its contrarian nature has led its exposure toward attractively priced companies in more value-oriented areas relative to the S&P 500 Index. Sector wise, the index's composition remained largely stable with industrials, health care, and consumer staples being overweight, while technology remained the most significant underweight.

Although the overweight to value stocks reduced slightly this quarter, several first-time index constituents were added at this quarter’s review reaffirming this value posture. The first timers added this quarter include industrial gas supplier Air Products and Chemicals (ADP), medical imaging leader GE HealthCare Technologies (GEHC), and industrial fluidics systems manufacturer Idex Corporation (IEX), among others, each bringing unique competitive advantages that have recently earned them 'wide moat' status from Morningstar. More information on these new entrants, and others, can be found in our recent blog covering the reconstitution in more detail.

Moat Index Sector Shifts Following 3Q 2024 Review | As of 9/20/2024

Source: Morningstar. As of 20/09/2024. 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 are, again, reaching all-time highs. 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 0.86, implying a 14% discount to fair value.

SMID Moat Index Highlights: Electrifying Surge in Utilities

The latest quarterly reconstitution of the Morningstar US Small-Mid Cap Moat Focus Index (SMID Moat Index) showcased notable shifts, emphasizing adjustments in sector and size exposure based on evolving market valuations and opportunities. A prominent change was the exit of four electric utilities companies from the index, prompted by a roughly 20% surge in their stock values during the quarter. This rotation out of utilities, which had become the largest industry overweight following the prior June Index review, made room for increased allocations in financials, materials, and health care sectors, all of which saw an uptick this quarter.

Additionally, the reconstitution highlighted a continued trend towards increasing small-cap exposure, which rose by 2.4% this quarter, bringing it to about 34%, a notable increase from the 23% small-cap exposure at the start of the year. This shift signifies a tactical move towards valuation opportunities that are present in the small-cap segment of the market. In terms of style exposure, there was minimal shift; the index continues to maintain an underweight stance on growth stocks, preferring tilts towards value and core stocks.

SMID Moat Index Sector Shifts Following 3Q 2024 Review | As of 9/20/2024

Source: Morningstar. As of 20/09/2024. 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 0.88 to 0.83 following the September review, signaling a 17% 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 the moat companies:

VanEck Morningstar US Wide Moat UCITS ETF (MOTU): 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 US Sustainable Wide Moat UCITS ETF (MOAT): US wide moat rated companies that passed ESG screens.

VanEck Morningstar US SMID Moat UCITS ETF (SMOT): small and mid-cap moat rated companies.

VanEck Morningstar Global Wide Moat UCITS ETF (GOAT): global wide moat rated companies.

Please be aware of risks, including the risk of investing in equities, US stocks, and the risk of investing in smaller companies.

The value of the securities held by a Moat ETF may fall suddenly and unpredictably due to general market and economic conditions in markets in which issuers or securities held by the funds are active. Investors should read the prospectus and other relevant documents before making the decision to invest.

To receive more Moat Investing insights, sign up to our newsletter.

IMPORTANT INFORMATION

This information originates from VanEck Securities UK Limited (FRN: 1002854), an Appointed Representative of Sturgeon Ventures LLP (FRN: 452811) which is authorised and regulated by the Financial Conduct Authority in the UK. The information is intended only to provide general and preliminary information to FCA regulated firms such as Independent Financial Advisors (IFAs) and Wealth Managers. Retail clients should not rely on any of the information provided and should seek assistance from an IFA for all investment guidance and advice. VanEck Securities UK Limited and its associated and affiliated companies (together “VanEck”) assume no liability with regards to any investment, divestment or retention decision taken by the investor on the basis of this information. The views and opinions expressed are those of the author(s) but not necessarily those of VanEck. Opinions are current as of the publication date and are subject to change with market conditions. Certain statements contained herein may constitute projections, forecasts and other forward-looking statements, which do not reflect actual results. Information provided by third party sources is believed to be reliable and have not been independently verified for accuracy or completeness and cannot be guaranteed. Brokerage or transaction fees may apply.

VanEck Asset Management B.V., the management company of VanEck Morningstar US Wide Moat UCITS ETF (the "ETF"), a sub-fund of VanEck UCITS ETFs plc, is a UCITS management company incorporated under Dutch law registered with the Dutch Authority for the Financial Markets (AFM). The ETF is registered with the Central Bank of Ireland, passively managed and tracks an equity index. Investing in the ETF should be interpreted as acquiring shares of the ETF and not the underlying assets.

VanEck Asset Management B.V., the management company of VanEck Morningstar US SMID Moat UCITS ETF (the "ETF"), a sub-fund of VanEck UCITS ETFs plc, is a UCITS management company incorporated under Dutch law registered with the Dutch Authority for the Financial Markets (AFM). The ETF is registered with the Central Bank of Ireland, passively managed and tracks an equity index. Investing in the ETF should be interpreted as acquiring shares of the ETF and not the underlying assets.

VanEck Asset Management B.V., the management company of VanEck Morningstar Global Wide Moat UCITS ETF (the "ETF"), a sub-fund of VanEck UCITS ETFs plc, is a UCITS management company incorporated under Dutch law and registered with the Dutch Authority for the Financial Markets (AFM). The ETF is registered with the Central Bank of Ireland, passively managed and tracks an equity index. Investing in the ETF should be interpreted as acquiring shares of the ETF and not the underlying assets.

The Morningstar^® Wide Moat Focus Index^SM are service marks of Morningstar, Inc. and have been licensed for use for certain purposes by VanEck. VanEck Morningstar US Wide Moat UCITS ETF (the “ETF”) is not sponsored, endorsed, sold or promoted by Morningstar, and Morningstar makes no representation regarding the advisability of investing in the ETF.

Morningstar^® US Small-Mid Cap Moat Focus Index^SM are service marks of Morningstar, Inc. and have been licensed for use for certain purposes by VanEck. VanEck Morningstar US SMID Moat UCITS ETF (the “ETF”) is not sponsored, endorsed, sold or promoted by Morningstar, and Morningstar makes no representation regarding the advisability of investing in the ETF.

The S&P 500 Index (“Index”) is a product of S&P Dow Jones Indices LLC and/or its affiliates and has been licensed for use by Van Eck Associates Corporation. Copyright © 2020 S&P Dow Jones Indices LLC, a division of S&P Global, Inc., and/or its affiliates. All rights reserved. Redistribution or reproduction in whole or in part are prohibited without written permission of S&P Dow Jones Indices LLC. For more information on any of S&P Dow Jones Indices LLC’s indices please visit www.spdji.com. S&P^® is a registered trademark of S&P Global and Dow Jones^® is a registered trademark of Dow Jones Trademark Holdings LLC. Neither S&P Dow Jones Indices LLC, Dow Jones Trademark Holdings LLC, their affiliates nor their third party licensors make any representation or warranty, express or implied, as to the ability of any index to accurately represent the asset class or market sector that it purports to represent and neither S&P Dow Jones Indices LLC, Dow Jones Trademark Holdings LLC, their affiliates nor their third party licensors shall have any liability for any errors, omissions, or interruptions of any index or the data included therein.
It is not possible to invest directly in an index.

Investors must read the sales prospectus and key investor information before investing in a fund. These can be obtained free of charge at www.vaneck.com, from the local information agent Computershare Investor Services PLC or from the Management Company.

All performance information is based on historical data and does not predict future returns. Investing is subject to risk, including the possible loss of principal.

No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission of VanEck.

Important Disclosure

This is a marketing communication for professional investors only. Please refer to the UCITS prospectus and to the Key Investor Information Document (KIID) before making any final investment decisions. This information originates from VanEck Securities UK Limited (FRN: 1002854), an Appointed Representative of Sturgeon Ventures LLP (FRN: 452811) which is authorised and regulated by the Financial Conduct Authority in the UK. The information is intended only to provide general and preliminary information to FCA regulated firms such as Independent Financial Advisors (IFAs) and Wealth Managers. Retail clients should not rely on any of the information provided and should seek assistance from an IFA for all investment guidance and advice. VanEck Securities UK Limited and its associated and affiliated companies (together “VanEck”) assume no liability with regards to any investment, divestment or retention decision taken by the investor on the basis of this information. The views and opinions expressed are those of the author(s) but not necessarily those of VanEck. Opinions are current as of the publication date and are subject to change with market conditions. Certain statements contained herein may constitute projections, forecasts and other forward-looking statements, which do not reflect actual results. Information provided by third party sources is believed to be reliable and have not been independently verified for accuracy or completeness and cannot be guaranteed. Brokerage or transaction fees may apply.

VanEck Asset Management B.V., the management company of VanEck Morningstar US Sustainable Wide Moat UCITS ETF (the "ETF"), a sub-fund of VanEck UCITS ETFs plc, is a UCITS management company under Dutch law registered with the Dutch Authority for the Financial Markets (AFM). The ETF is registered with the Central Bank of Ireland, passively managed and tracks an equity index. Investing in the ETF should be interpreted as acquiring shares of the ETF and not the underlying assets. Investors must read the sales prospectus and key investor information before investing in a fund. These can be obtained free of charge at www.vaneck.com, from the local information agent Computershare Investor Services PLC or from the Management Company.

Morningstar® US Sustainability Moat Focus Index is a trade mark of Morningstar Inc. and has been licensed for use for certain purposes by VanEck. VanEck Morningstar US Sustainable Wide Moat UCITS ETF is not sponsored, endorsed, sold or promoted by Morningstar and Morningstar makes no representation regarding the advisability in VanEck Morningstar US Sustainable Wide Moat UCITS ETF.
Effective December 17, 2021 the Morningstar® Wide Moat Focus IndexTM has been replaced with the Morningstar® US Sustainability Moat Focus Index.
Effective June 20, 2016, Morningstar implemented several changes to the Morningstar Wide Moat Focus Index construction rules. Among other changes, the index increased its constituent count from 20 stocks to at least 40 stocks and modified its rebalance and reconstitution methodology. These changes may result in more diversified exposure, lower turnover and longer holding periods for index constituents than under the rules in effect prior to this date.
It is not possible to invest directly in an index.

All performance information is based on historical data and does not predict future returns. Investing is subject to risk, including the possible loss of principal.

No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission of VanEck.