The S&P 493 has come to embody the left-outs. Those whose earnings haven’t grown, and probably despair in envy of the Mag7. Mag 7 returned 80% in 2023, compared to 23% for S&P500 and in the mid teens for S&P493. Mag7 now represent 30% of the S&P500 compared to only 14% in 2017. Their rule is predicated on their superior margins 19% (vs 19% for S&P493), and their large cash piles, which insulated them grandly from higher interest rates. They won flat out in 2023.
This winning trade convinced large swath of investors to crowd in, not only in tech but also in equities overall. Deutsche estimates at $40bn the cumulative flows into Technology stocks in 2023. Investors have turned overweight equities at the end of 2023, as per NAIM (National Association of Active Investment Managers) and BoFa Fund Manager Survey.
Where do we go from here? It is fair to say that the market is pretty hot right now. The CNN fear-greed index clearly leans on the “extreme greed” level, as a function of low volatility, equity price upside momentum of the past 3 months, low put-call ratios, to name a few.
So far, a strong US economy still warrants the lofty market level, as proven this week by surprisingly high NFP, and job reports, even though manufacturing PMI still remains on the backfoot, and services ISM showed the first sign of weakness in a while. But it also comes with higher yield expectations, and it would have escaped no one that the 10-year yield is now a touch away from 4% again.
From here, I believe in a reality check in Mag7, notably for Tesla and Apple that are facing some competition headwinds, as EV competition beefs up and AI-devices could topple iphones’ dominance. If it happens, I’d see this as a buy opportunity in Tech, as long as their free cash flow superiority remains.
Elsewhere in equity, the pivot is likely to continue into Healthcare, Utilities, Energy, Consumer Staples, Financials and Real estate. I see that as a return to the mean long-term valuations of sort, against the assumption of peak rates.
A rebalancing should happen in S&P493, and in midcap and smallcap alike. However, I’d take this view with a massive bucket of salt, and would call for a drastic selection of names. Remember that (i) high rates are still impacting disproportionately smaller companies, and (ii) ~40% of Russell 2000 still has negative earnings.
Overall in 2024, I’d refrain to play such rebalancing with indices, for once. Just think about the overall effect on the S&P500 of a rebalancing out of the Mag7 into the 493 others if the Mag 7 represent 30% of the index. Yes, it could be a massive zero-sum game.
Having said that on equity, let’s not forget that equity risk premium are disappointingly low, as a function of inflated valuations and high fixed income rates. Therefore, I believe that 2024 will be a year for bonds overall. Cash pays 5%+, US corporate 5.4%, and US high yield 8%. The term premium is not huge, as spread compressed a lot over the past 3 months. Nevertheless, a 5% to 6% annual return for 10-year with quality bond-like risk is nothing to be frown at.
Whatever the strategy is, it is likely to come with higher tax confiscation in order to replenish the bare national coffers, so plan accordingly.
Let’s finish with what I believe are the main outlier risks in 2024, namely politics and geopolitics. In 2024, elections are scheduled to occur in 30 democracies.
These elections would reveal the continued erosion of participation, a sign of increasing distrust for institutions, which would play in favor of “authoritarian” firebrands. Immigration and migration are likely to be hot debates, as wars and climate-change-triggered famine foster clashes among populations, and globalization is being re-thought. Of course, this would rekindle nationalistic sentiment, along with the question of what it means to be from here or there.
Europe is particularly exposed in a scenario of increased political frictions, as it thrives on consensus. Growth has been a quarter of US growth in 2024, so there is arguably a potential rebound surprise there. European markets (as seen from a US investor) could be further boosted by a relative strengthening of the EUR vs USD, although some played out already in 2023. Tactically, I’d over-weight even though the political risk is high in my opinion.
Geopolitics will not cease to surprise either. A likely resolution of the conflict in Ukraine, is only going to stop for a while the imperialistic expansion of Russia. War in Gaza is unlikely to escalate into a world conflict, however it adds fuel to the fire between the North-South relations.
There is a renewed attempt from the South to propose an alternative to the post WWII order. While it often leads to more global chaos, the recent expansion of the BRICS to Saudi Arabia, the UAE, Iran, Egypt, and Ethiopia paves the way toward a more organized development. Don’t hold your breath though, as BRIC were coined in 2001, and have largely undershot the promise so far.
In the short-term though, countries leaning toward the North would benefit most, namely Vietnam, India, Indonesia, Poland and Mexico. They stand to benefit from a reorganization of the global supply chain toward more “friendly” epicenters. As an investor, I’d monitor opportunities there.
Would I discount China going forward? Well, let’s acknowledge that China has been a painful bleeding wound for investors for the past 4 years, myself included. However, I dare to call once more for peak negativity on China, and believe in the huge financial capacity of the country to harness the challenges of its real estate sector, revive consumer sentiment, and finalize their death-by-one-thousand-cuts reforms of the business sector. If it fails, my consolation would be that it would prove that an autocratic government can only go so far in the prosperous development of its country.
Stay safe out there !
360 Advisory LLC is a Boston-based RIA managing investments