After accelerating into the back half of 2023, the U.S. economy has begun to slow down. Over the short-term, there are a number of potential headwinds: high policy rates, cost pressures and geopolitical uncertainty. All of this weighs on both corporate and consumer confidence. Still, taking a longer-term view, significant fiscal spending, particularly on infrastructure (such as the Inflation Reduction Act and the CHIPS and Science Act), coupled with growing enthusiasm around generative Artificial Intelligence, should provide an accommodative backdrop for stronger secular growth moving forward.

Markets don’t seem to have fully priced in this prognosis, reflected in the narrow (and narrowing) nature of the equity market rally: the “Magnificent 7” has massively outperformed the rest of the market, up roughly 30% since the start of the year compared to around 5% for the remaining companies, on AI-related headlines and strong earnings growth. Moreover, while fundamentals for companies outside of the biggest winners are likely to improve as earnings growth looks set to re-accelerate in the back-half of the year, valuations remain depressed relative to the broader market. These names could therefore function like “coiled springs.”

While this potential opportunity set is broad – 490-plus companies in the S&P 500 alone – and in many ways transcends the style-box spectrum, value names, particularly those with an exposure to the “goods” portion of the economy, may be particularly interesting. Some examples of this include:

• Semiconductors: Within this cyclical industry, automobile-related semiconductors have been the best performers as of late. However, depressed areas like personal electronics, communications and enterprise, may soon bounce back as demand is reinvigorated off low levels left behind by pandemic “over-ordering”,  underscoring that  semiconductor opportunities exist outside of AI.
• Rail and Parcel: Strong wage growth and recession fears acted as headwinds to freight, but unexpected economic resiliency and the growing need to move materials associated with fiscal stimulus and AI should be a catalyst for outperformance. Automation has also significantly improved efficiencies.
• Home improvement: Higher interest rates and COVID-era renovations have reduced demand for capital investment at home. However, with the average U.S. home age increasing, the likelihood of significant maintenance expenditure is increasing. Moreover, labor-related backlogs in older projects are clearing, as immigration has helped solve labor shortages.

All told, while the U.S. equity market may seem unapproachable at first blush – thanks to stretched valuations and all-time-high prices in the S&P 500 – savvy investors can stay constructive by remembering that the opportunity set extends beyond a small handful of names. For those investors looking away from the recent winners, “goods”-exposed sectors may play an important role in long-term equity portfolio construction.

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