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16th September 2020

Market update

Regular readers will know that we have discussed before the dislocations currently found throughout financial markets and the last two weeks has brought one of these back into focus.

On the day I last wrote to you, a six day sell off in the US markets commenced, led by technology stocks. The following chart shows the relative performance, month to date, of the technology heavy NASDAQ versus the S&P 500 and the Dow Jones, which is skewed towards more economically sensitive companies:

Dow jones graph

What I find most interesting here is the performance on the S&P 500. As I have written previously, the big technology companies have been a major beneficiary from the accelerated changes in consumer behaviour as a result of the global pandemic and their share prices have outperformed by a wide margin this year, despite the recent falls:

Security

Total Return YTD

Alphabet 14.61%
Amazon 70.80%
Apple 57.38%
Facebook 32.73%
Microsoft 32.39%
S&P 500 6.73%

The outperformance of these five names over recent years means that they now make up just under one quarter of the S&P 500, as demonstrated by the following chart from Goldman Sachs:

5 largest companies

Why am I mentioning this? Well, there are a few key reasons:

Firstly, the record concentration in the US equity index means that its fortunes are dictated by just a few companies more than at any point in the last 40 years. This could lead to higher levels of volatility going forward, particularly as we head into the US presidential elections in November (I will come on to this a bit later). I would also urge any readers who are investing in index trackers to be mindful of the underlying constituents of the index and to make sure you are comfortable with any potential risks.

Secondly, following the recent drop in share prices, many commentators have been quick to call “the end of the tech bubble”. This leads to two important questions; are tech stocks in a bubble and, has it burst? Honestly, we don’t know. However, for most of these companies mentioned here, they have visible earnings, solid balance sheets and reasonable growth potential. In our view, some profit taking was inevitable but we, as you know, would not be as presumptuous as to try and make such bold predictions.

Thirdly, some other “tech” names have experienced an even wilder ride this year. I will use Tesla as an example:

graph18sep tesla graph

Here, we can see that the performance of Tesla has eclipsed that of even Amazon so far this year, rising some 537%. However, the two companies could not be more different in terms of balance sheet strength or profitability. Amazon is vastly more profitable and yet the share prices lagged Tesla. Could this be the sign of irrational exuberance? Possibly.

I highlight this because we firmly believe in investing in proven companies and managers across our services and solutions. While outsized returns can be made from the likes of Tesla, we view this as a highly risky investment and prefer not to hold large positions in such names where possible (although some of our US fund managers may have small holdings) in favour of seeking consistent, attractive risk adjusted returns.

Finally, clients are asking about the US presidential election and the potential market impact. I must state that I cannot give my political views here. The race is closer than one might think, and we shouldn’t rule Donald Trump out just yet. Having said that, all signs are currently pointing towards a victory for Joe Biden.

Trump is, arguably, the more market friendly candidate, at least in the short term. Biden has promised a reversal of most of the Trump era tax cuts and other measures which analysts estimate could reduce the earnings of the S&P 500 by about 12%. However, as we all know, promises made on the campaign trail are often watered down considerably upon reaching power.

Perhaps more worryingly, Biden is also increasing rhetoric around instructing the Department of Justice to launch an anti-trust investigation into the big tech companies, just as Elizabeth Warren did back in 2016. Should this materialise, it would cast greater uncertainty over future earnings which would, in turn, mean higher share price volatility. As I have demonstrated, because of their sheer size, this would lead to higher volatility for the S&P 500 as a whole.

Trying to position for the outcome of the elections is, in our opinion, foolhardy. We simply do not know who will win and so, as always, we prefer to make sure that we have well diversified portfolios with no outsized biases to any particular style or sector.

Until next time, stay well.

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