At a glance
- Equity markets have had an overall positive year so far. This has largely been driven by a handful of stocks, and valuations increasing.
- The increased disparity in sector performance offers a potential opportunity for active managers.
- After a tough start to the year, the fixed income market has become more attractive to investors.
The first half of the year could be described as a bit topsy turvy, with some high-profile failures being reported alongside companies boasting record revenues and profits. Globally, inflation has fallen but still remains high, while the ongoing war in Ukraine, geopolitical uncertainty, and record heatwaves have all added to a state of economic nervousness.
This uncertainty across the macroeconomic environment has filtered through into financial markets, with assets usually considered less risky, like bonds, going through a phase of high volatility earlier in the year.
March saw the failure of Silicon Valley Bank and other US regional banks. This was largely due to company specific issues that were exacerbated by the rise in interest rates and the subsequent impact on the value of their bond investments.
This was followed by the takeover of Credit Suisse by UBS, which further contributed to volatility in the bond market, particularly in the banking sector, with the fear of contagion and more widespread failures.
Thankfully much of this has settled as the year has progressed. In many ways now is an attractive time to be buying high quality credit, such as investment grade bonds, with spreads on offer fairly compensating default risk.
Stocks and shares
Turning to equities, volatility has been more muted compared to bond markets, but this doesn’t mean that challenges don’t exist.
For example, taking a closer look at the MSCI World Index, a small number of names have significantly influenced its overall performance. In fact, between the start of 2023 and the end of July, almost half of the returns of the index can be attributed to the top 10 most valuable companies.
This is among the highest levels seen in the past 20 years. Driven by tech giants like Microsoft, Apple, Alphabet and Amazon, US equities have continued to be the most expensive compared to other regions.
The chart below shows the contribution of the top 10 stocks in the MSCI World Index to the overall return of the index. This emphasises the impact these leading shares have on its performance.
Source: MSCI, FactSet, SJP. Discrete data as of 31 July 2023
Past performance is not indicative of future performance.
Please note it is not possible to invest directly into the MSCI World Index and the figures shown above do take into account any charges applicable to the appropriate investment wrapper or any relevant tax charges.
The concentration in the equity market, with returns being driven by a small number of large companies, has led to a particularly challenging period for active managers.
Unless managers have held a significant amount of these top performers, they would have struggled to beat the market. The top 10 out of the 2,883 businesses in MSCI All Country World Index account for 18% of the total market capitalisation. Investing in these companies is unlikely to be where an active manager perceives they have any informational advantage. It is therefore common for managers to have less exposure to these companies than the market average.
Another important factor is valuation. Currently, the top 10 companies have a price-to-earnings ratio of 45 times their forecasted earnings for the next fiscal year, on average. This is relatively high by historically standards.
The high prices of these top companies deter many value-oriented managers, who prefer to invest in companies that seem reasonably or undervalued.
This development could lead to risks for passive investors, as this concentration could see their investments largely relying on the performance of just a few companies. If these companies struggle in the future, it will have a magnified impact on them. And, given the turbulent political climate, with potential tail risks impacting currency, inflation and macroeconomics, diversification remains key.
For active managers, this also provides an opportunity. Lofty valuations are concentrated in industries closely tied to technology. There are broad sections of the market that remain attractively valued for managers willing to conduct sufficient due diligence and invest for the long-term.
Read here for a wider look at the market in 2023 so far, as well as how our fund managers are coping.
The value of an investment with St. James’s Place will be directly linked to the performance of the funds you select and the value can therefore go down as well as up. You may get back less than you invested.
SJP Approved 04/08/2023