Global stock markets closed June up 3% in the second quarter and 12% higher for first half of the year[1]. The MSCI All Country World Index entered July at a record high, thanks largely to the US where the S&P 500 (+16% YTD) and Nasdaq (+20% YTD) indices also broke new ground at the end of the second quarter.
These impressive returns have been achieved despite prevailing economic headwinds. Growth remains sluggish, consumer sentiment is deteriorating and interest rates are higher than anticipated at the start of the year as inflation stubbornly sits above long-term target levels. The geopolitical backdrop has also been challenging with long-running conflicts in Ukraine and Gaza, as well as unexpected election outcomes in India and Europe, failing to slow the market’s momentum.
You don’t need to look too far beneath the surface, however, to see that a dwindling number of stocks are driving performance. AI-related companies were responsible for all the S&P 500’s gains during the second quarter – Nvidia alone contributed almost half – and the continued dominance of the US market.
European equities gained a solid 6% over the first half, albeit returns were similarly concentrated in just two companies; Novo Nordisk and ASML, both of which have climbed around 45% and I’m happy to say are in our portfolios[2]. Emerging markets are 7% higher for the year, with continued strong performance from China (+3%), Taiwan (+29%) and India (+16%), helping to offset disappointing returns from Korea (-0.5%) and notably Brazil (-22%)[3].
AI dominance has had a familiar impact on global sector performance with Information Technology (+25%) and Communication Services, (+21%) leading the charge this year, while Consumer Discretionary (+5%), Consumer Staples (+3%), Materials (-1%) and Real Estate (-2%) have all struggled, reflecting the economic headwinds mentioned above. This saw Growth (+17%) outperform Value (+7%) over the first half and the former now trades at a 100% valuation premium based on forward earnings[4].
A dwindling number of winners has inevitably made it harder for stock pickers to beat the market. Indeed, data from Morningstar Direct shows that only 18.2% of actively managed funds benchmarked against the S&P 500 are ahead of the index at the half-year stage. With the heavy lifting being done by the most expensive companies, conditions have been particularly challenging for value investors like SKAGEN. Although most of our equity funds have delivered solid absolute returns, all were behind their benchmarks at the half year stage – while this is clearly disappointing, periods of underperformance are an inevitable part of being an active manager.
Bubbling under
The market’s shrinking breadth means that Microsoft, Apple, Nvidia, Amazon, Meta and Alphabet now represent over 30% of the S&P 500 index and nearly 20% of the global benchmark. With valuations and investors’ expectations for continued earnings growth sky-high, these companies’ margin for error appears similarly narrow, and for passive investors tracking these indices, the concentration risk is increasingly active.
The benefits of investing globally should also not be underestimated. Valuations in emerging markets and Europe remain attractive with forward earnings multiples below long-term averages and at record discounts to the US of 40% and 30%, respectively. Even in the US, where most sectors are trading above long-term averages, the headline P/E multiple is heavily skewed by the IT sector which is now priced 70% higher than its own 10-year average and at a level last seen when the dot com bubble burst.
One of Warren Buffett's most famous quotes is that “only when the tide goes out do you learn who has been swimming naked” and investors are becoming increasingly nervous about rising tech valuations. The latest Bank of America Global Fund Manager Survey showed that 69% of respondents believe that owning the Mag 7 stocks is far and away the most crowded trade, up from around 50% in May.
The same survey also revealed that investors have been selling tech stocks for three consecutive months with the average allocation now a net 20% overweight, which is its lowest since October 2023 and below the 20-year average of net 22% overweight.
I have been cautious about this area of the market for much longer and believe our prudence will ultimately be rewarded. Despite a relatively disappointing first six months of the year for our funds, I believe our investment approach remains the right one and will continue to yield the best long-term results for clients. Having courage in our convictions is important at times like these, particularly as we may face rising geopolitical and economic uncertainty ahead.
We have navigated periods of market distortion before and there is no better substitute than holding a balanced portfolio of thoroughly researched companies. Valuations across our funds offer the greatest upside for some time and provide the best protection against being caught out when the market tide eventually turns.
[1] MSCI All Country World Index in USD, as at 30/06/2024.
[2] MSCI Europe Index in USD, as at 30/06/2024.
[3] MSCI Emerging Market Index and MSCI country indices in USD as at 30/06/2024.
[4] MSCI ACWI Growth Index (26x forward P/E) vs. MSCI ACWI Value Index (13x forward P/E).