Is market leadership moving on?

For much of the past decade, and particularly over the past 18 months, global stock markets have been led by small, concentrated groups of companies. The Magnificent Seven in the US, the ‘GRANOLAS’ in Europe. The phenomenon has even been evident in Asia markets, with the semiconductor names leading the way. This has been a tough environment for active managers, but there are signs of change.

In a recent strategy paper, Goldman Sachs said: “Stock market concentration has increased dramatically and has taken three broad forms: the rise in the share of the US equity market in the world, the rise in the share of the technology sector, and the rise in the dominance of the biggest companies in most regions”.

It attributes this to a number of factors: the outperformance of growth stocks over value against a backdrop of very low interest rates, higher liquidity, the growth of the US economy relative to its peers, and stronger earnings for the largest companies*.

It has been a tough backdrop for active managers who often can’t have the same weightings in these companies as the index. Even if they wanted to, they are constrained by their risk parameters. There is also an existential point: they need to ensure they are different from the index to outperform it.

Winds of change

However, over the past few months, there are signs that this is changing. The Magnificent Seven has dwindled to a Fab Four (or even the Thrilling Three). Superstar Nvidia failed to impress the market with its recent results. Revenues grew 122%**, but investors had hoped for more and the share price has been weak. The dominance of the US appears to be faltering, and in other markets, there have been signs of market leadership broadening out into new sectors and into mid and small cap companies.

Stuart Rhodes, manager of the M&G Global Dividend fund, says: “Nvidia’s quarterly results in 2023 ignited the AI phenomenon, which has run ever since. But it has started to even out over the past three to four months. Since the summer, it has been a much more level playing field.” He says this market concentration has been ‘brutal’ for dividend investors because many of the top-performing companies do not pay dividends or only very small ones, so any shift is welcome.

What has changed the market mood? “Partly it’s just the law of large numbers,” says Stuart. “These companies became more expensive. It is also clear that the Federal Reserve is reversing its monetary policy stance. That gives more support to the rest of the economy. A lot of areas have been in recession for some time and are now starting to emerge from that.” He has been picking up opportunities in unloved ‘quality’ companies, particularly in the consumer staples sector. Valuations have fallen and he believes investors may start to reappraise them in a new market environment.

European markets

Francis Ellison, portfolio specialist on the CT European Select fund, believes the most significant adjustment is likely to be seen in the US where the concentration is at its most extreme. He says that there has been an erroneous view that the only people who can make money in global stock markets are a handful of people in California “The world will wake up to that and these companies will derate.” He says there have been some parallels in Europe, but the phenomenon hasn’t been as acute.

While he sees market leadership broadening, he still holds a number of the dominant stocks – ASML, Novo Nordisk, SAP – believing that they have further to go. He says that when growth is tough and difficult to find, those companies that can display growth will price at a premium. “The economy is tough. There are long-term structural problems, political issues and high debt.”

He does hold some ‘good cyclicals’ such as reinsurance companies. He also has selective holdings in some luxury goods groups such as LVMH. He has pared back some holdings on price grounds. He recently sold Swiss group Sika for example, buying Saint-Gobain instead, which is undergoing restructuring and trades at a lower price.

Wider opportunity

The concentration in the market has broadened the opportunity set for value managers in recent years, taking it beyond its traditional sector hunting grounds. Nick Kirrage, manager on the Schroder Income fund, says there is a lot of deep value hiding in plain sight. He points to NatWest, where the share price is up over 50% since the start of the year. “We are now pretty excited about domestic UK companies. The government and regulators appear quite aligned.” He says there is also plenty of yield available across the market, which also expands the universe of available options.

If the new environment persists, it would be a welcome relief for many active fund managers, who have had to battle an environment where the largest companies have ruled the roost. Investors may finally start to explore opportunities elsewhere.

*Source: Portfolio Strategy Research, 11 March 2024

**Source: Nvidia, 22 May 2024