Investors may have their portfolios on autopilot during another outstanding year for US stocks, but a veteran strategy chief says it's time to change course — even if there's no imminent crash.
For most of the past two years, there was little debate over the place to be in markets. Mega-cap growth stocks dusted their smaller peers for 18 months, beginning in early 2023.
A septet of stocks known as the Magnificent Seven more than doubled last year, while the rest of the S&P 500 mustered a respectable low-double-digit gain that was slight by comparison. The so-called S&P 493 then got lapped four times by the Mag Seven in the first half of 2024.
That trend is no longer intact. Since the start of July, the Magnificent Seven stocks have trailed the rest of the market, albeit only by a few percentage points. This role reversal has happened as the S&P 500 hit record highs, meaning that the market is no longer reliant on mega caps.
In fact, 300 companies have beaten the broader market so far in the second half of 2024, which is close to double the rate from the prior year and a half.
Such a leadership shift may be jarring for some, but it's comforting for Brian Belski, the chief investment strategist at BMO Capital Markets. A top-heavy market is an unhealthy one, which is why he's been excited to see smaller stocks starting to step up in recent months.
Some in markets may not even be aware of this regime change. There's long been a narrative that mega caps are the best and safest place to be, but it no longer seems to be a reality.
"Investors appear to be either missing or ignoring some key beneath-the-surface trends," Belski wrote in an October 23 note.
How to get the best of both worldsMega-cap technology stocks were largely attractive due to their outstanding earnings growth. These firms steadily expanded while posting profits that dwarfed nearly all of their peers.
This strength was no secret, which was why investors had to pay up to get exposure to top names. By contrast, small- and mid-cap companies continued to trade at a substantial discount.
Fortunately, investors don't have to choose between fast-growing companies and fairly valued ones. BMO has long highlighted stocks that offer growth at a reasonable price, or "GARP." These firms have above-average earnings growth and cheaper-than-average valuations, and they have an impressive record of outperformance over the last few decades.
While GARP stocks couldn't keep up with the Magnificent Seven in its heyday, Belski noted that the group has mounted an impressive second-half turnaround that seems to have momentum.
Stock valuations have been elevated for years, and while BMO isn't scared away by that fact — as evidenced by the firm's decidedly bullish year-end S&P 500 price target of 6,100 — it's also relaying to clients that past data suggest that GARP stocks should perform even better.
"When stocks start to become more expensive, investors often seek lower-cost alternatives, thereby boosting the performance of those stocks," Belski wrote, noting that wide valuation gaps across individual companies, instead of just the broader market, can also be a tailwind.
Belski later added: "Reasonably valued companies with better growth prospects are the stocks that are typically rewarded under these conditions."
Without potent earnings, GARP stocks could risk falling into the "value trap" category. And although the group's forward profit outlook has lagged the market for over a year, Belski noted that the earnings growth gap narrowed meaningfully as its performance improved.
Growth-heavy stocks like those in the Magnificent Seven usually fare best when the market's growth is lackluster, as was the case for much of 2023 and the start of this year.
However, when earnings take off as much as they're expected to in 2025, investors no longer feel the need to pay a premium for profit growth. Cheaper GARP stocks should become more appealing in that backdrop, according to BMO, and historical performance backs that up.
13 cheap, fast-growing stocks to buy nowRoughly 60% of S&P 500 stocks have outperformed the market in the second half of 2024, which means that active managers who choose wisely should follow suit.
"We believe these trends, should they continue as we expect, are an ideal environment for stock-pickers," Belski wrote.
BMO generated a GARP list of 71 stocks with higher forward earnings growth than the median S&P 500 component as well as lower price-to-earnings (P/E) and P/E-to-growth (PEG) ratios than the index's median name, but only 13 of those are outperform-rated by the firm's analysts.
Below are the 13 top-rated GARP names, along with their tickers, market capitalizations, and P/E ratios.