Moat Stocks Hit Pause Following Strong Year

Equity markets started the year with a cautious tone following the blistering rally seen in the final quarter of 2023.Large caps regained their leadership position in January with the S&P 500 Index up slightly on the month, while small caps slid nearly 4%. Much of the negative price action of smaller companies came on the back of hawkish language during the January Fed meeting that pushed back expectations for interest rate cuts. However, strong performance by the familiar mega caps helped buoy the market but has also reignited concerns around narrow market leadership.

After outperforming the S&P 500 Index by more than 6% in 2023, the Morningstar Wide Moat Focus Index (the “Moat Index”) returned some of that relative outperformance to begin the new year. The Moat Index fell 1.75% during January, compared to the S&P 500 which returned 1.68%. The Equal Weight S&P 500 Index was also down during month, nearly 1%, highlighting the continued dominance of the mega cap “Magnificent Seven” cohort.

Smaller-cap companies gave back some relative performance versus their large-cap peers after having outperformed during the fourth quarter rally of last year. The Morningstar US Small-Mid Cap Moat Focus Index (the “SMID Moat Index”) fell 2.77% in January, landing squarely in between the performance of the pure small and mid cap broad benchmarks.

U.S. Equities Cautious After 4Q 2023 Rally | As of 1/31/2023

Source: Morningstar. As of 1/31/2024. Past performance is no guarantee of future results. Index performance is not representative of fund performance. It is not possible to invest directly in an index. Fund performance current to the most recent month end is available by visiting vaneck.com or by calling 800.826.2333.

Moat Index Top Contributors and Detractors

Underperformance of the Moat Index was in part due the Index’s equal-weight methodology, which leads to structural under-exposure to mega caps, but stock selection and earnings-related volatility also proved impactful during the month. Volatility around earnings results was also a theme that impacted the Moat Index last year during the third quarter as well. However, many of those companies went on to rebounded in the subsequent quarter.

MarketAxess (MKTX)

This month MarketAxess was the largest detractor to performance and the primary example of the above mentioned earnings-related volatility. MKTX released their fourth-quarter earnings results on January 31st with shares of the company down nearly 18% on the day. Despite the disappointing earnings, Morningstar analyst Michael Miller did not anticipate any material change to his $305 fair value estimate for MarketAxess and viewed the company as undervalued following the news.

Morningstar Analyst Comments | by Michael Miller, CFA - January 31, 2024
Wide-moat-rated MarketAxess reported decent fourth-quarter results that were largely in line with our expectations as the firm benefited from higher trading volume industrywide. The firm's uninspiring market share performance, however, remains a concern. Fourth-quarter revenue increased 10.9% to $197.2 million, or 6.6% when adjusted for the acquisition of Pragma. Meanwhile, earnings per share increased 16.5% to $1.84 from $1.58 last year, although the company did benefit from an unusually low provision for income taxes in the quarter. As we incorporate these results, we do not plan to materially alter our $305 per share fair value estimate for MarketAxess, and we see the shares as undervalued at current prices.

RTX Corp (RTX)

On the more positive side of the earnings releases this month was aerospace and defense company RTX which beat expectations leading to an 8% share price gain in January. This price action landed RTX in the top slot in terms of contribution to performance for the Moat Index during the month. Morningstar analyst Nicolas Owens maintained his $112 per share fair value estimate following the release and noting that company is well positioned for secular growth in commercial aerospace.

Top Contributors and Detractors from Moat Index - January 2024

Source: Morningstar, January 2024. Past performance is no guarantee of future results. Index performance is not illustrative of fund performance. Not intended as a recommendation to buy or to sell any of the securities mentioned herein.

SMID Moat Index Top Contributors and Detractors

The smaller cap SMID Moat Index also experienced a bit of turbulence from earnings related volatility this month. Beyond MarketAxess, which was already covered above, diversified global specialty chemicals company DuPont (DD) was also under pressure following disappointing earnings and lower 2024 guidance. While Morningstar analyst Seth Goldstein, CFA reduced his fair value estimate from $90 to $85, he still views DuPont shares as undervalued.

Morningstar Analyst Comments | by Seth Goldstein, CFA - January 24, 2024
At current prices, we view DuPont shares as undervalued, with the stock trading in 4-star territory. We point to the recovery of the electronics business as a catalyst for shares throughout the year. In the release, management said the semiconductor technology business generated sequential revenue growth. This is in line with our long-term view that DuPont should benefit from solid demand for its products that are used to make semiconductors and interconnected solutions. A return to growth in the electronics business, which generates the majority of profits, should support the stock.

Names that positively contributed to the SMID Moat Index performance during the month include news and sports focused broadcast network Fox Corp (FOXA) and life sciences cloud-based software solutions company Veeva Systems (VEEV). The Financials sector was also well represented within the top contributors with Bank of New York Mellon (BK) and Interactive Brokers Group (IBKR) both up over 7% in January.

Top Contributors and Detractors from SMID Moat Index - January 2024

Source: Morningstar, January 2024. Past performance is no guarantee of future results. Index performance is not illustrative of fund performance. Not intended as a recommendation to buy or to sell any of the securities mentioned herein.

Accessing Moat Stocks

VanEck Morningstar Wide ETF (MOAT) seeks to replicate as closely as possible, before fees and expenses the price and yield performance of the Morningstar Wide Moat Focus Index.

VanEck Morningstar SMID Moat ETF (SMOT) seeks to track as closely as possible, before fees and expenses, the price and yield performance of the Morningstar US Small-Mid Cap Moat Focus Index.