The debate between a potential recession and a soft landing has resurfaced, prompted by weaker-than-expected ISM manufacturing data from the U.S. earlier this week. Similar to what we saw in early August, this has reintroduced volatility into the markets, with equities feeling the bulk of the pressure.
On a positive note, our defensive assets have continued to fulfil their purpose during these periods of market stress. Fixed income (investment grade and high yield), alongside alternatives—particularly our allocation to Real Assets—has performed well, helping to cushion the impact on multi-asset portfolios. We have discussed the importance of diversification and the value of our alternatives allocation in previous Market Updates, so we won’t reiterate those points here. Instead, we remain focused on navigating these uncertainties with a well-diversified, balanced approach.
Sticking with the plan
Although we continue to keep a close eye on the macroeconomic events, we are not overly concerned with the latest developments. Macro strategists TS Lombard are still of the belief that a soft landing rather than a recession is a more likely outcome – ‘Fed cuts, still resilient hard data in cyclical sectors, a dearth of serious macro-financial imbalances, and support from earnings all suggest the bull market is not on the brink.’
In our opinion, one of the most significant risks in today’s markets is elevated valuations, particularly within the U.S. and technology sectors. While there is no immediate catalyst for a correction—especially given the substantial influence of passive investment flows showing no signs of abating—we believe that starting valuations play a crucial role in shaping long-term returns.
We are still mindful of the risks associated with investing in great companies at inflated prices. This awareness is reflected in our continued preference for valuation-conscious managers, which has resulted in an underweight position in both the U.S. and technology sectors compared to most global benchmarks. While this stance has posed a headwind to performance year to date, we are more comfortable with a portfolio that takes on a more diversified and balanced set of risks within the equity market. For now, we see no reason to make significant changes to portfolios.
Sticking with the plan
As reminder of the concentration of returns in the main MSCI World Global Index: Over 18.5% of the index is concentrated in the well-known Magnificent Seven group of securities. Although the returns are certainly not as concentrated as in 2023, which we have welcomed, some stocks are doing a disproportionate amount of the heavy lifting with the fortunes of the MSCI World and these large US technology companies closely aligned.
As reminder of the concentration of returns in the main MSCI World Global Index: Over 18.5% of the index is concentrated in the well-known Magnificent Seven group of securities. Although the returns are certainly not as concentrated as in 2023, which we have welcomed, some stocks are doing a disproportionate amount of the heavy lifting with the fortunes of the MSCI World and these large US technology companies closely aligned.
Regarding high valuations in the US technology sector, the other significant market news to occur since our last update was the widely anticipated Nvidia quarterly results. Highlights below:
- Record quarterly revenue of $30.0 billion, up 15% from Q1 and up 122% from a year ago
- Record quarterly Data Centre revenue of $26.3 billion, up 16% from Q1 and up 154% from a year ago
Despite delivering record results, which slightly exceeded prior expectations, the market reaction was unfavourable, with the share price dropping over 6% on the day of the results reducing the company’s market capitalisation from $3.0898 trillion on August 28th to $2.6053 trillion. To put this in perspective, this one-day decline in market value was larger than the entire market capitalisation of AstraZeneca, the FTSE 100’s largest company. Since the results were published, the stock has declined approximately 15%, highlighting the risks when companies are potentially priced for perfection by the markets.
Dario Perkins, Managing Director Global Macro at TS Lombard expressed a couple of views which we sympathise with and thought we would share.
"As an economist - not a market strategist - my first “hot-take” on NVIDIA comes from many years watching macro surprise indices. Those things are mean-reverting, because it is impossible to keep surprising analysts in the same direction. Eventually, the consensus will catch up and the spread narrows (or even overshoots). So, it should be no surprise (pun intended) that NVIDIA beats are also mean reverting, something that was lost on a lot of the media coverage last week.’
‘The surge in NVIDIA’s earnings comes from the massive investment in AI being done by the other big tech companies. This creates a circular dynamic, that leaves NVIDIA (and now the US stock market in general) dependent on continued big AI investments. If the Big Five stop investing – or, perish the thought, find a different chip supplier – we could have a problem. The question is not whether we have a Dotcom-style valuations bubble, but an “earnings bubble”.
At Tideway, we don’t question the quality of companies like Nvidia or other well-known U.S. technology giants. However, we do wonder whether these companies can continue to surpass already elevated expectations, or if the market has gotten ahead of itself. While we have ample exposure to the Artificial Intelligence theme through various fund managers, our exposure remains below that of the index, and less concentrated in the top names.
For now, we will continue to adopt a more balanced and, in our view, less risky approach—even if that means potentially facing some short-term performance headwinds.
- The content of this document is for information purposes only and should not be construed as financial advice.
- Any rates of return used are for illustrative purposes only. Please be aware that the value of investments, and the income you may receive from them, cannot be guaranteed and may fall as well as rise.
- Any rates of tax referred to are correct as at the date of this document and may be subject to change in the future.
