ClockWise: Mega Caps and MAGA Caps: Thoughts on US equities now and in the near future

It’s been a rollercoaster year for US equities which began with sharp declines but are now back at all-time highs following the recent two months of strong performance. 

In the near term, US stocks can continue to outperform their global peers, if investor sentiment remains euphoric against a backdrop of positive trade developments and stellar company earnings. However, longer term could be more challenging for the region. US stocks are expensive, and performance continues to be driven by a small number of trillion-dollar tech companies. Risk premium has risen for the country and while markets seemed to have brushed aside concern around tariffs and policy for now, this could change as the impact on economic data and company profits becomes more apparent.

US stocks are expensive, and performance continues to be driven by a small number of trillion-dollar tech companies.

A weak start to the year, followed by a strong recovery

US stocks have enjoyed a sustained period of outperformance over recent years. In fact, 2022 has been the only year in which US stocks underperformed their global peers since 2012 (Bloomberg). The heavy bias of the US equity index to the technology sector and mega-cap growth names has certainly been a key driver of this.

However, the start of 2025 proved much more difficult for the US market. Concerns around policy and tariffs, and worries of a new AI model from DeepSeek, that is far cheaper than the US based company alternatives, saw the S&P 500 index witness its 11th quickest correction since 1928. This was the largest quarterly underperformance of US stocks versus the rest of the world since 2009.

However, after a historically poor start to the year, US equities have staged a striking comeback. The S&P 500 index has not only clawed back losses but pushed to all-time highs, driven by a narrow but powerful rally in mega-cap stocks — the so-called “Magnificent Seven”.

Chart 1: US equities have outperformed since Liberation Day

Source: Royal London Asset Management and LSEG Datastream.

Further to run yet on the US equity market rally?

This recent bout of strong US equity market performance has been supported by easing recession fears and resilient company earnings.

In this recent US corporate earnings season, corporates have delivered solid beats and reinforced the narrative that the US remains the global growth engine. Heading into US Liberation Day, we noted that analysts’ expectations for US earnings had been steadily worsening. However, the last two months have seen steady upgrades to the point where the US is now the region with the most attractive relative earnings picture of all equity regions globally.

More generally, US stocks have benefitted from progress away from the high levels of tariffs initially announced on US Liberation Day and towards various trade deals. This has seen recession probabilities fall and calmed down investor fears.

In fact, our proprietary sentiment indicator last week closed at its most euphoric level in over a month (Chart 2). This is a stark recovery from April, when our measure of investor sentiment fell to its third most depressed level in history on an intraday basis. In the near term these animal spirits could have further to run, and stocks can continue to grind higher, supported by strong corporate earnings. 

Chart 2: Investor Sentiment and Global Stock Prices

Source: Royal London Asset Management and LSEG Datastream. Composite sentiment indicator includes factors related to market volatility, retail investor bullishness and US directors dealing in shares in their own companies. A reading of -1 or lower indicates a market panic and contrarian buy signal, a reading of greater than +1 indicates bullish investor sentiment. As at 08/11/2024.

Political risk, policy uncertainty and valuation concerns: a more challenging environment long term?

However, we do not think this US outperformance will last forever. While investor sentiment can remain euphoric for an extended period of time, we have yet to see the full damage caused by tariffs on US consumers or corporates. Perhaps this will be the turning point for investors.

More broadly, with President Trump now well into his second term, US policy uncertainty remains a key risk. While markets have so far shrugged off the noise, the potential for abrupt shifts — especially in trade and fiscal policy — looms large. The resurgence of ‘Make America Great Again’ (MAGA) caps on US Capitol Hill may be symbolic, but it also signals a return to a more combative and inward-looking policy stance that could unsettle global investors.

The resurgence of ‘Make America Great Again’ (MAGA) caps on US Capitol Hill may be symbolic, but it also signals a return to a more combative and inward-looking policy stance that could unsettle global investors.

A loss of confidence from the investor community is not difficult to envision, which could have a very damaging effect on the equity market if we see global capital rotate away from US assets.

Increased policy risk in the country draws more attention to a more fundamental challenge facing US equities in the longer term:  valuations. US stocks are trading at a forward P/E multiple well above long-term averages (Chart 3), and the concentration risk in a handful of expensive mega-cap stocks has reached extreme levels. The top seven names now account for over 34% of the index (Datastream) — a dominance not seen since the dot-com era, with well-remembered consequences.

Historically, valuations have been a reliable predictor of forward returns. Elevated multiples tend to correlate with lower future performance (Chart 3). This raises concerns about sustainability, particularly if earnings growth in mega-cap names begins to slow.

Chart 3: Long term valuations; US is still expensive, which does not bode well for future returns

Source: Bloomberg, LSEG DataStream and RLAM as at May 2025. Cyclically adjusted PE (Shiller PE) data from December 1981 to June 2025.

Short term gain but long-term pain?

In short, we see a divergence between the tactical and the strategic thinking. In the near term, a tactically positive view of US stocks makes sense due to the strong relative earnings picture and supportive technical backdrop. But structurally, the US equity market faces headwinds that are hard to ignore. Expensive valuations, political risk, and the potential for a regime shift in global trade all argue for caution.

Mega caps may be leading the charge today, but we are dubious whether the region will continue to be so great in the future.

For professional investors only.  This material is not suitable for a retail audience. Capital at risk. This is a financial promotion and is not investment advice. Past performance is not a guide to future performance. The value of investments and any income from them may go down as well as up and is not guaranteed. Investors may not get back the amount invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change. Forward looking statements are subject to certain risks and uncertainties, actual outcomes may be materially different from those expressed or implied.