Morning Note: Market news and our thoughts on stock market concentration.
Market News
US equity markets drifted lower last night: S&P 500 (-0.3%), Nasdaq (-0.4%). Merck rose 5% post-market after it won FDA approval for a new treatment for high blood pressure.
This morning in Asia, the yen touched its lowest level versus the dollar since 1990 (151.97), before pulling back after Japan’s finance minister warned of “bold” action. Japanese equities moved higher (Nikkei 225, +0.9%), while other Asian markets fell: Hang Seng (-1.6%); Shanghai Composite (-1.3%). China’s industrial profits rose 10.2% in the first two months of the year in a sign the economy is stabilising.
The FTSE 100 is currently trading 0.2% lower at 7,921. Reckitt Benckiser has announced the acceleration of its share buyback programme to reflect the Board’s confidence in the continued strong free cashflow generation of the business. The final £500m tranche will now be completed in July, three months earlier than previous guidance. DS Smith is up 8% after it confirmed it is in discussions with International Paper regarding an all share offer at 415p a share, a 48% premium to its undisturbed share price on 7 February 2024, the day prior to the commencement of the offer period.
Ahead of key US inflation data, the 10-year Treasury yields 4.23%. The oil price slipped to $84.50 a barrel against a backdrop of rising US inventories. Iron ore extended its biggest daily loss in about two weeks on signs of weak steel demand in China. Gold trades at $2,180 an ounce.
Owning a property in London remains better value than renting even after mortgage rates more than doubled, according to Halifax data. The average monthly cost to first-time buyers was £2,241, or £12 cheaper than renting. Sterling trades at $1.2630 and €1.1664.
Source: Bloomberg
Market View – Stock Market Concentration
The fact that market gains in the last year have been driven by a very small cohort of very large US technology companies has garnered much attention in the financial press recently. For those interested in the issue and what it means for their portfolios, Goldman Sachs has recently published a Strategy Paper on the subject which is outside their usual restricted access. The report titled “The Concentration Conundrum; What to do about market dominance” is linked below.
The report breaks down the concentration issue into three components. The concentration in US stocks as a proportion of Global Stocks, the concentration of the technology sector within equity markets (and in the US in particular) and concentration at a stock level with the dominance of the so-called “magnificent seven”. There are lots of good charts in the report which readers can see for themselves which highlight the issue well.
The broad conclusion to the report is that while much of the success of these dominant stocks is justified by their fundamental performance, they also concede that dominant companies rarely stay the best performers for long periods of time and suggest diversifying portfolios. We agree with this conclusion.
For example, the table below shows the largest companies at the beginning of each of the preceding decades, starting with the 1980s.
Source: Gavekal/Macrobond
At the start of the 1980s the top ten stocks were dominated by oil companies after the sky-high oil prices of the 1970s. Over the decade oil prices collapsed along with the dominance of the sector. By 1990, the bubble in Japan meant eight of the top ten stocks were Japanese. The bubble burst and these companies proved to be dreadful investments. By 2000 technology stocks dominated the top stocks and were largely wiped out by the dot com bust. In 2010s Chinese stocks were a big feature, to be followed by a terrible decade for Chinese stocks. As we entered the 2020s, US Tech occupied the top five positions and while they have had a good start to the decade, historical precedent would caution against going all in on them continuing to do so.
Passive Flows
Source: Goldman Sachs
One area that the report makes brief mention of as a contributing factor for the outperformance of the largest companies is the flows into passive funds which have a momentum reinforcing effect on markets. We have written on this dynamic in the past and feel that its impact is significant. Anything that causes a reversal of these flows could have an outsized negative impact on the biggest stocks.
Diversification is one of the few free lunches available to investors. Many investors, possibly unwittingly, are ignoring this when they chase recent performance and construct index weighted portfolios.