LT Views Winter-2025-SINGLE-build08 - Flipbook - Page 9
James
Klempster
Stock markets in 2024 were dominated by a handful of tech-centric
names in the US with the flow of capital into AI-related themes being
a powerful driver of returns. The top 10 companies (by market size)
accounted for a record 37.3% of the S&P 500’s market capitalisation.
Indeed, 26 stocks now account for half the entire value of the S&P 500. This has in turn led to the US market forming
an ever-increasing proportion of the global market; US stocks now make up two-thirds of the MSCI All-Country
World Index. This article will discuss four themes to think about for 2025.
Exceptionalism isn’t the norm
The past decade has seen the regular
outperformance of both the US stock market
and economy, meaning it can be difficult to
envisage periods where this is not the case. But
it happens; markets don’t outperform forever.
In the early noughties, the US experienced a decade in
the doldrums following the unwind of the dotcom boom,
a phase in markets that seemed as unstoppable as the AI
behemoths today. Global pools of capital that can flow
to any corner of the world’s markets can break the reflex
of buying US stocks and can, instead, seek out cheaper
opportunities. If the notion of a market’s exceptionalism
means anything, it is surely that it can’t be the norm.
Big doesn’t have to be beautiful
Large market capitalisation companies
generally should be considered less
nimble and adept at providing pro-cyclical
returns. Smaller companies are generally
considered to be higher risk and, therefore,
should be more rewarding over the medium
to long term.
This so-called risk premium – a return that should accrue to
those willing to weather the additional volatility of small cap
companies – has been notably absent in recent years. In
fact, in many ways, smaller companies have been penalised
by the market due to their perceived riskiness despite their
fundamental flexibility, entrepreneurship and dynamism.
Conversely, large capitalisation companies, which are,
generally, far harder to run with entrepreneurial verve
and flexibility should trade at a valuation discount to
their smaller counterparts. The stodginess, which is an
inevitable consequence of large companies’ size, is a
virtue in the sense it should provide a consistent foil to
the vacillations of small cap companies and yet some of
the largest companies in the world are currently trading
at what can best be described as speculative valuations.
These valuation levels – such as price earnings ratios
that are multiples of long-term norms – may make sense
if applied to small and hyper nimble companies whose
profitability is doubling, trebling or even increasing ten-fold.
But when they are applied to companies whose revenues
and profitability have already increased in an exponential
way to levels that dwarf the GDP of small countries, a note
of caution is sensible.
Massive momentum opens up
active opportunities
The momentum in markets has been
breathtaking in the past couple of years.
The human desire to keep up with the
pack – otherwise known as FOMO – is
a powerful force. Momentum trades work because they
draw in capital and this can create a self-fulfilling, virtuous
cycle. The more focused these flows become, the greater
the opportunities are for active managers to operate in
the areas of the market and asset classes that are out of
favour and are less frothy.
Popular investments are rarely cheap. But cheap
investments offer excellent long-term returns prospects.
Looking to invest in unloved corners of markets can also
reduce overall portfolio risk because you are investing in
assets that are priced for less good outcomes. Portfolios
that are priced for perfection have plenty of scope for
disappointment.
Patience pays
Over the short term, markets can be volatile
and driven by sentimental forces such as
fear and greed, whereas over the longer
term fundamentals such as valuations and
the economy have greater influence on
market returns. Historically, investing over the longer
term has reduced the impact of market volatility and
increased the proportion of time that investments are in
positive territory.
The turning point for markets – sometimes referred to as
an “inflexion point” – often comes when news flow is
negative. To illustrate this, the two best days for the UK
stock market over the past 40 years were in the shadow
of Lehman Brothers going bust in 2009 and the Covid
lockdown in 2020, neither periods that were positive.
The stock market turns long before the news does and
investors who have sold would need a mighty strength of
character and conviction to reinvest with perfect timing.
LIONTRUST VIEWS – WINTER
9
