Equity investors have ultimately been enjoying a period of pretty strong returns recently, with markets up around 11% pa in the last five years, well ahead of their long-term average of around 8% per annum (source WTW). However, this strong period of returns is masking some challenges that investors have been facing during this time, particularly around market concentration. There is an enormous skew towards a small number of very large companies in the index and a long tail of thousands of companies that are tiny in their allocations. What this means is whilst passive investors have been enjoying low costs and reasonably good returns if they've been fully invested for that period, they are now increasingly exposed to a small number of companies that are a key driver of their returns. Just in the first six months of this year, the largest five companies in the global index contributed more than 40% of the returns of the whole index (source WTW).
The second issue is volatility i.e. how much and how quickly the price of an asset, like a stock or a market index, changes over time. Investors have experienced bouts of volatility recently, with the volatility index (or VIX, which measures the markets expectations of volatility, where a high VIX value indicates significant market volatility or uncertainty and a low VIX value suggests that investors expect stable, less volatile market conditions), jumping up from near its lows to near its highs in a very short period of time. The spotlight has also been on comparing the size of some of the largest companies to the size of total stock markets of individual countries e.g. compare Apple or Nvidia to the size of the UK, Germany, Canadian or Australian market and you can see that these companies are now bigger than whole stock markets, see chart below. If the whole stock market, like the UK market, went down 10% in a day, (that would be a very rare event) and would have a big impact around the world. Interestingly, companies like Nvidia go up and down 10% relatively often in a day. So the volatility seen in these companies, that are larger than the stock markets of these countries, is a significant risk for investors.
Index concentration poses challenges for active management (where stockpickers try and beat the market), especially as top stocks in the index become increasingly dominant. This concentration means that for active investors to outperform, they often need to focus heavily on a small group of large companies—such as the “Magnificent 7” (Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla), which have led global equity indexes since early 2023. Individual managers have investment styles that come and go in and out of favour, and therefore having exposure to one style of investing that's the flavour of the month at the moment is a risky strategy for investors because it creates volatility and periods of underperformance which can be tough to handle. A prime historic example of this risk is Nokia, whose market cap peaked at around $290 billion in June 2000 (source FactSet) during the dot-com bubble but declined sharply as competition in the smartphone market intensified and they ultimately did not keep pace, highlighting the dangers of concentrated exposure to stocks that are currently doing well.
The way we think about dealing with some of these challenges is to have a diverse multi-manager portfolio where we can use diversity to blend away some of these investment styles that lead to these periods of outperformance and underperformance of individual managers. Diversity refers to the inclusion of a variety of investment managers with different styles, strategies, and perspectives within a single investment portfolio. By blending such managers together, we can make a portfolio that does not have exposure to these big factor swings that drive these periods of out- and underperformance, giving investors a smoother ride.
Source: MSCI, Market capitalisations are in USD billions as of 30 September 2024.
Countries are represented by the following indices: MSCI United Kingdom, MSCI France, MSCI Germany, MSCI Canada, MSCI Australia.
The Noise
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The US federal reserve has its next interest rate decision meeting next week, with two key economic indicators falling short of expectations. GDP expanded at an annualized rate of 2.8% in Q3 2024, which was below the forecasted figure of 3%. This indicates an unexpected deceleration in economic growth, which is consolidated by JOLTs also being below consensus. This measures job openings in the U.S., and it dropped to 7.44 million, below the market expectation of 7.99 million. These figures being below expectation show a slowing US economy and jobs market, two key areas that the Federal reserve will consider when deciding whether to cut rates.
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The US equity markets have slipped around 1% this week. Contextually, we are in the middle of earnings season where public companies reporting their profits, which brings added volatility to US markets. Especially as five of the ‘Magnificent Seven’ US companies have reported their earnings this week. Markets watch the magnificent seven particularly closely as they account for around 30% of US markets. Overall, it has been an been a disappointing earnings season for the magnificent seven thus far, with only Alphabet and Amazon ahead of expectations. It is essential to view this overall volatility in the context the imminent U.S. election, which will inevitably influence the volatility of market dynamics in the near future.
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The transition to a low carbon economy has faced a setback this week; The EU trade association, Eurogas, abandoned its deal which promised to retrain workers. Eurogas represents gas energy companies operating in the eurozone, including the likes of Shell, TotalEnergies and Equinor. The ‘Just Transition European Framework Agreement’ was supposed to provide workers with legally binding guarantees in anticipation of abandoning fossil fuels. This is a setback for the EU’s decarbonisation plans as it now faces potentiality large-scale layoffs when it eventually moves away from oil and gas in the energy transition. Note that the negotiations are still being closely followed but the European Commission, which still maintains its aim to push the EU to be net zero by 2050.
The Numbers
GBP Performance to 31/10/2024
Equity GBP Total Return
|
1 Week
|
YTD
|
MSCI ACWI
|
-0.8%
|
15.5%
|
MSCI USA
|
-1.0%
|
19.5%
|
MSCI Europe
|
-1.3%
|
5.3%
|
MSCI UK
|
-2.0%
|
8.2%
|
MSCI Japan
|
2.8%
|
7.2%
|
MSCI Asia Pacific ex Japan
|
-0.8%
|
13.1%
|
MSCI Emerging Market
|
-0.7%
|
10.8%
|
MSCI EAFE Index
|
-0.4%
|
6.5%
|
Fixed Income GBP Total Return
|
|
UK Government
|
-1.5%
|
-3.3%
|
Global Aggregate GBP Hedged
|
-0.4%
|
2.6%
|
Global Treasury GBP Hedged
|
-0.3%
|
2.2%
|
Global IG GBP Hedged
|
-0.5%
|
3.2%
|
Global High Yield GBP Hedged
|
0.1%
|
9.2%
|
Currency moves
|
|
|
GBP vs USD
|
-0.6%
|
1.3%
|
GBP vs EUR
|
-1.1%
|
2.7%
|
GBP vs JPY
|
-0.5%
|
9.2%
|
Commodities GBP return
|
|
|
Gold
|
0.9%
|
31.3%
|
Oil
|
-0.6%
|
-2.2%
|
Source: Bloomberg, data as at 31/10/2024
The Nuance
This week, the term "budget" has taken centre stage, sparking a flurry of discussions around taxation and government debt in the UK. To truly understand the market's response to Chancellor Rachel Reeve’s announcement, we can delve into this week’s movements across UK Gilts, AIM, and the equity markets.
Gilts (UK government debt) yields (which have an inverse relation with prices). These have risen since Wednesday, hitting a 2024 high of 4.42. This week has seen the biggest increase in yields in a year as markets digest the Labour government's plans, with 10-year UK yields set for biggest weekly jump since mid-2023. Though bond markets have adjusted following the budget, the speed and scale of the move has fallen far short of the crisis that rocked markets in September 2022 after an interim budget from then-Prime Minister Liz Truss.
The AIM (alternatives) market saw a spike after Reeves reduced the IHT business relief by half for qualifying AIM shares. It was feared that all IHT relief would be removed on investments in business-relief-qualifying AIM shares, and as a result the AIM market climbed on Wednesday afternoon, with a 4% “relief” rally.
The UK equity markets were unfazed on budget day. Looking ahead, investors have scaled back bets of rate cuts from the Bank of England, taking the view that the budget has upwardly adjusted the UK’s forecasted inflation path. Prior to the budget, markets had expected five quarter-point rate cuts by the end of 2025, now this just sits at three quarter-point cuts. The pound is down -0.6% vs the dollar this past week.
All in all, a lot was said on Wednesday, and there is still a lot to unpack, from specific tax technicalities to pointed political jibes. Yet, something we can look forward to from this budget is a “penny off a pint in the pub” point, with Draft Duty being cut by 1.7% in February next year.
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Any views expressed are based on information received from a variety of sources which we believe to be reliable, but are not guaranteed as to accuracy or completeness by atomos. Any expressions of opinion are subject to change without notice.