Is it time for traders to swap the Magnificent Seven giants for smaller US corporations?

Once again last year, the US stock market was dominated by the Magnificent Seven – with some spectacular share price returns.

Chip maker Nvidia, the biggest hitter among group, rose 171 per cent in 2024, while Meta and Tesla rose more than 60 per cent.  Amazon, Alphabet and Apple racked up gains of between 44 per cent and 30 per cent and even the straggler, Microsoft saw its shares climb 12 per cent.

The Magnificent Seven constitute almost a third of the US’s chief index, the S&P 500, and their gains account for more than half of its returns last year.

Their performance has proved highly beneficial for returns over the past two years, but investors face a conundrum.

On one hand, there are concerns that when the Magnificent Seven’s run breaks, share prices will be hit hard. On the other, investors are reluctant to bet against so-called US exceptionalism.

After Donald Trump’s election win, one way investment experts suggest to play this scenario is to back American stock market fortunes swinging a different way – and switch attention to US medium and smaller-sized companies.

The Magnificent Seven have become increasingly dominant in the large cap US market – and this matters to investors around the world.

The importance of these superstar firms stems from the fact that in turn the US stock market makes up about 74 per cent of the global stock market, as measured by major indices such as the MSCI All World Index.

As a result, many investors holding global funds – particularly index trackers – will find that they have significant exposure to mega-cap US stocks. 

Rory MacPherson, chief investment officer of Magnus FDM, said: ‘Over half of the returns in the US stock market last year came from just seven stocks, with the so called Magnificent Seven up by circa 70 per cent as a cohort. 

This group of stocks have lived up to their billing over the past year and have demonstrated 100 per cent growth in their profits (on a year-over-year basis), which has powered their share prices.’

Trump’s tariffs: winners and losers 

With Trump soon to be in the White House, the new presidency is likely to signal positive news for financial markets – and the US stock market led by the Magnificent Seven giants rose substantially on his election win.

Investors faced a rockier ride through December, on fears that markets will suffer as the US Federal Reserve cuts rates by less than previously expected.

Nonetheless, the general sentiment is that Trump 2.0 will be good for big tech. 

But while the tech giants’ bosses have been keen to cosy up to the President-elect, his policies may favour firms further down the scale. 

Trump has made known his intention to pursue a nationalist and protectionist attitude towards business, and put ‘America first’.

The big loser as a result is likely to be China, which will potentially face significant trade tariffs. While, in theory, the big winner should be US domestic firms.

In his campaign, Trump pledged to institute a 10 per cent flat rate on all imports, a 60 per cent rate on imports from China and a 100 per cent tariff on car imports.

Experts suggest his actual policies are likely to be less extreme in practice and the may use the threat of tariffs more than the charges himself. 

Nonetheless, the risk of a trade war looms large and this could spell bad news for giant global US tech companies that do substantial business in China.

There are concerns that Trump’s policies would be unsettling for large international US firms and prove to be inflationary, but overall domestic-focussed small and mid-caps may see a sales and profit boost from such measures.

Jason Hollands, managing director of Bestinvest, told This is Money: ‘It remains to be seen as to whether the campaign rhetoric gets watered down in practice, but the overall direction of travel is positive for US domestically biased equities.’

Smaller firms will also benefit from less competition from abroad, allowing them to maximise growth in the US. 

Indeed, Mick Gilligan, head of managed portfolio services as Killik, said: ‘Trump’s stance on trade supports investment in US small caps, given their domestic US bias, unlike large caps, which tend to have globally diversified revenues.’

How Trump could boost US smaller companies 

The Trump presidency is expected to offer looser regulation and lower taxes, both of which will be to the benefit of US-based firms.

Combined with the planned tariffs, lower taxes should benefit firms who produce their goods on US soil.

Hollands said: ‘President-elect Trump’s tariff plans are part of a stick and carrot approach to drive both overseas companies and US firms who had offshored production outside of the US to move production to the states. 

‘For example, his proposed corporate tax cuts provider much greater reward to businesses who produce goods in the US.’

Trump posted on social media platform X: ‘Any person or company investing ONE BILLION DOLLARS, OR MORE, in the United States of America, will receive fully expedited approvals and permits, including, but in no way limited to, all Environmental approvals. GET READY TO ROCK!!!’.

Hollands says: ‘The incoming US administration’s fiscal agenda comprising corporate tax cuts, deregulation and tariffs on imports has the scope for materially boosting domestic growth.

However he warns that that this could also stoke inflation if Trump chooses to rapidly instate his new policies. 

A return of inflation would cause a headache for the Federal Reserve on interest rates and if rates were to stall or even rise again, this could impact smaller and medium-sized businesses that are more exposed to borrowing costs. 

Small caps offer better value

One of the common criticisms of US mega caps is that they are expensive.

It has paid handsomely to ignore that in recent years, but the fact remains that US stocks are pricey.

Of course, while a high price-to-earnings ratio can indicate that a stock is overvalued, it can also be show that investors are confident in the future of a firm and are willing to back it.

‘Valuations also support a case for small caps versus large,’ Gilligan told This is Money. 

‘The S&P 500 trades on 24.6x this year’s expected profit levels, falling to 21.6x next year, implying profit growth of 14 per cent in the next year.

‘Using the same measure, the small cap Russell 2000 Index, trades on 19.7x this year’s expected profits, falling to 15.9x next year, a growth rate of 24 per cent. The lower PE multiple and higher earning’s growth make a strong case for investing in US small caps.’

For investors, this means that the possibility of a favourable market environment under Trump could make small and mid-cap businesses increasingly attractive investments.

James Carthew, head of investment companies at QuotedData, told This is Money: ‘There are plenty of long-term studies that suggest small caps should beat large caps. However, ahead of the election, small caps had been underperforming large caps for a long time.

‘Currently, markets are being driven by a narrow group of mega caps. Perhaps Trump’s policies will be the trigger for that to broaden out.’

Indeed, Trump’s win did signal an upswing in sentiment among small cap investors. The small-cap Russell 2000 index jumped directly in the wake of the election result, closing six per cent higher on 5 November.

Hollands said: ‘We think that backing funds with exposure to US small and mid-cap stocks is a key way to play the US market given the direction of travel, rather than the typically popular route of owning S&P 500 Index trackers which are heavily weighted to the Magnificent Seven big tech stocks.

‘The Magnificent Seven have been fantastic performers with all the excitement about AI, but there are now tentative signs of a broadening out of the US rally to other parts of the US market where valuations are less extreme.’

Which funds can you buy to back US smaller companies?

‘There is not a vast choice for investors looking for pure US small cap exposure through an investment company,’ Carthew said.

However, he tips JPMorgan US Smaller Companies (ongoing charge 1.72 per cent) and Brown Advisory US Smaller Companies (ongoing charge 1.6 per cent) as two options for investors.

He said: ‘The JPMorgan trust is larger, more liquid, has lower fees, and a better track record. The only downside is that it is much more expensive (or rather less cheap), trading on a 1.1 per cent discount to the Brown Advisory trust’s 10.5 per cent. Neither offers much of a yield – these funds are really all about capital growth.’

Killik’s Gilligan also tips JPMorgan and Brown Advisory’s offerings, as these are the only trusts that purely focus on US small caps.

He said: ‘BASC invests in good quality companies with dependable, recurring profitability and would be my pick for someone looking for US small cap exposure right now.’

Caledonia Investments, currently trading at a 39 per cent to NAV, also has a portfolio of US mid cap unlisted businesses, accounting for 20 per cent of its portfolio.

Meanwhile, Bestinvest’s Hollands tips Premier Miton US Opportunities fund (ongoing charge 1.59 per cent), which has 75 per cent exposure to US mid and small cap stocks, and the Federated Hermes US SMID Equity fund (ongoing charge 1.59 per cent). The Hermes fund invests in both small and medium sized US firms with a 40 per cent exposure to industrials and 19 per cent exposure to tech.

He also suggests the Xtrackers S&P 500 Equal Weight UCITS ETF for those looking for a passive fund.

Hollands said: ‘In our managed portfolios, since the election we have increased exposure to the US, with a skew to small and midcap funds, as we as funds that are exposed to the S&P 500 on the basis of equally weighting stocks rather than based on the market cap of constituents.’