Reimagining Growth: A Market Beyond Mega-Caps

By Vinay Thapar, CFA and John H. Fogarty, CFA

Broadening US Market Opens Wider Growth Opportunities

Past performance does not guarantee future results.

*FAANGM includes Meta Platforms (Facebook), Amazon, Apple, Netflix, Alphabet Inc. (Google) and Microsoft.

†Where securities have been excluded from the index, the excluded weights were reallocated amongst the remaining holdings on a market-cap weighted basis.

Left display through December 31, 2022; right display as of February 17, 2023

Source: FactSet, FTSE Russell and AllianceBernstein (AB)

US growth stocks were hit hard in last year’s downturn, with the mega-caps accounting for nearly half of the market’s decline. Now, the changing contours of the market mean investors can capture a broader array of recovery candidates while incurring less benchmark risk.

Last year’s shake out of mega-cap US stocks is reshaping the market. The so-called FAANGM stocks—Meta Platforms (Facebook) (META), Apple (AAPL), Amazon (AMZN), Netflix (NFLX), Alphabet Inc. (Google) (GOOG)(GOOGL) and Microsoft (MSFT)—dominated market performance for several years. At its peak in January 2022, the FAANGM cohort comprised 36% of the Russell 1000 Growth benchmark. By the end of last year, that group comprised 29% of the index (Display).

Bigger Pond for Growth Investors

To be sure, the aggregate weight of the largest companies is still above pre-pandemic levels. Yet when the market capitalization of stocks worth a combined $7 trillion falls by a few points, it opens the door for a wider array of stocks to contribute to market and portfolio returns. This means discerning investors have a bigger pond to fish in for companies with resilient businesses, solid profitability and attractive growth prospects that can perform well through challenging economic times.

Market data show that features like these can be found away from the mega-caps. For example, in mid-February, the Russell 1000 Growth’s return on assets—a key measure of profitability—was 16.2% and its sales growth was 9.6%. When you strip Apple out of the index, profitability declines, but growth actually increases. And when the entire FAANGM cohort is removed, profitability is still quite attractive and growth largely unchanged, in our view. In other words, we believe it’s possible to create a diversified portfolio of attractive US growth stocks today without making sacrifices or concentrating too heavily in the largest names.

Improved Conditions for Risk Budgeting

Of course, some mega-caps will retain dominant business positions and may continue to offer attractive investing opportunities. However, passive portfolios will be forced to own the entire cohort. We believe each company should be evaluated individually and held at positions appropriate to a portfolio’s investment philosophy and discipline. In an environment of structurally higher inflation and interest rates, increased selectivity is essential to identify those with robust long-term growth prospects.

By positioning beyond the mega-caps, portfolio managers can also improve their risk budgeting. A broader benchmark reduces the tracking error of portfolios with large underweights of mega-caps.

The moral of the story? Portfolios seeking to capture future market leadership don’t have to rely on yesterday’s champions to drive tomorrow’s returns.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams and are subject to revision over time.

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