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        Weekly ETF Brief

        US Mid Caps: The Goldilocks Equity Exposure in a Trump World

        US exceptionalism remains intact — supported by a rare combination of robust growth and monetary easing. But adding to US large caps to capitalize poses challenges for investors. Indices are concentrated and elevated valuations already reflect a benign macro environment. In contrast, US mid caps offer more direct access to strengths of the US economy, trade at more affordable P/E multiples, and appear likely to benefit more from the new administration’s policies. And mid cap companies tend to be less volatile than small cap exposures, providing the right environment for further exposure.

        5 min read
        Krzysztof Janiga, CFA
        Senior Equity ETF Strategist

        Macro Picture: US Bests the Rest

        The economic leadership of the United States continues to contrast with sluggish growth in the rest of the developed world. GDP growth expectations for the US remain significantly higher, and economists’ forecasts continue to be revised upwards — even the realized number for 2023 has been significantly revised. US exceptionalism, combined with disinflation, and monetary easing, makes us more constructive regarding risk-on exposures. The election outcome introduced new risks in form of expected changes to the immigration policy, fiscal spending outlook and potential tariffs, but simultaneously it created opportunities for mid-cap equities through a more benign tax policy, more deregulation and increased focus on domestic businesses. Mindful of this risk-reward balance, taking the mid-cap middle path may be the optimal solution in the upcoming months.

        Figure 1: Real GDP Forecasts (Bloomberg Consensus)

        US economic forecasts are more posititive than the rest of the world

        The Sweet Spot

        Mid Cap equities often sit in the sweet pot between large and small caps. They allow investor access to US exceptionalism, trade at relatively undemanding valuation multiples, and they retain the high growth potential of small caps but include more established businesses with easier access to capital — which remains a relevant trait given still restrictive monetary conditions1. Arguably most well-known mid cap exposure is the S&P Mid Cap 400 Index, which consists of companies with a median market cap of $6.8bn2. The exposure has been a hidden gem for European Investors but is being uncovered and is gaining popularity. The S&P MidCap 400 is not a niche exposure, with total market cap of $3.3tn — bigger than large cap European indices such as MSCI France, MSCI UK or MSCI Germany. Most importantly mid cap equities provide a more direct exposure to US economy when compared to large caps, as they generate approximately 77% of their revenue within the US. The corresponding number for the S&P 500 is 59%3. Another appealing feature of the S&P Mid Cap 400 Index is lower concentration as top 10 companies in the index represent only 7% of the exposure, making it far more diversified than the S&P 500, where the top ten stocks account for 35% of the index weight4.

        Figure 2: Index Market Capitalization

        Charts shows the scale of the US mid cap sector compared with European countries' total equity markets

        Sectors Tailored To Play US Economic Strength

        The S&P Mid Cap 400 Index sector split is largely cyclical, with Industrials representing more than a fifth of the exposure. Industrials benefit from multi-year programs like the Infrastructure and Jobs Act, the CHIPS and Science Act and the Inflation Reduction Act. The latter may be partially rowed back under the Trump administration but by and large these fiscal programs are endorsed by both parties on a state level, so reductions may be limited. Potential tariffs introduce broad-based risks, but at the same time raise demand for supply chain facilitators, reshoring and nearshoring, where industrial companies may play a key role.

        Financials, which represent 17% of the Index, are the most obvious beneficiaries of the Republican sweep. Expected deregulations in the banking sector may boost revenue, reduce costs, and steepen the yield curve, supporting net interest margins. Mid cap banks may enjoy stronger tailwinds due to their more direct exposure to the US consumer when compared with global large cap institutions.

        The third largest sector is Consumer Discretionary, which includes a large share of retailers, hotels and restaurant operators benefitting from remarkably robust consumption in the US which continues to exceed economist’s expectations. This more balanced composition stands in contrast with the S&P 500 where two stocks account for half of the sector.

        There is also an overweight towards Materials, Real Estate and Energy. US mid caps are underweight in defensive sectors such as Health Care and, most importantly, Technology. 

        Figure 3: Sector Composition

        Mid cap indexes have a different sector exposure to large caps

        Performance Begins to Turn

        After an 18-month period of a narrowly-driven rally in large caps, US mid cap equities have begun to outpace the S&P 500 since July, as monetary easing combined with the continuous strength of US economy allowed for a broadening of market performance. Looking at a longer timeframe, the S&P Mid Cap 400 Index has delivered much stronger returns since the beginning of the century, even though the past several years brought the domination of technology giants. Geopolitical fragmentation combined with the US exceptionalism has created favorable conditions for domestic mid cap equities to prosper going forward.

        Figure 4: Long Term Performance

        Sector performance between mid caps and large caps has markedly differed

        Valuation Multiples Remain Relatively Affordable

        The Forward Price to Earnings multiple of the S&P MidCap 400 Index is 17.5x — slightly above 10y average but it does not seem expensive, given the strength of the US economy and the monetary easing. On a relative basis, US Mid Caps trade at much more undemanding multiples when compared to the S&P 500’s 22.2x P/E ratio. This is even more pronounced when analyzing historical patterns over the last 10 years, as the current valuation gap is in the 90th percentile of monthly observations. As valuation levels remain a key concern for investors considering US equities, the broad market-cap-weighted S&P MidCap 400® Index offers a solution to that challenge.

        Figure 5: Price to Earnings 1y Forward

        Chart shows that large caps have been more expensive than mid caps for some time

        Earnings Growth Rebound Expected

        Earnings of the S&P MidCap 400 in 2024 are likely to see a 4% contraction (while the S&P 500 earnings growth will be driven by Magnificent 7 stocks, and the broader technology segment). But a double-digit rebound is expected in 2025 and 2026. In our view this is likely to materialize, given the macroeconomic backdrop.

        Figure 6: Earnings Growth Forecasts

        Mid cap earnings are forecast to grow faster than large caps next year

        How to Gain Access to US Mid Cap Equities?

        SPY4 GY

        SPY4 GY

        SPDR® S&P® 400 U.S. Mid Cap UCITS ETF (Acc)

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