Is This The Start of The Great Rotation?
- Dominant market themes reverse in July
- Expensive valuations require continued earnings momentum
- Past performance is a not realiable indicator of future performance
Dominant Market Themes Reverse in July
Market trends reverse in July - can this trend continue in the H2? Figure 1 highlights the negative returns to the themes that have dominated markets in recent years. Momentum, quality and growth themes along with Technology and Communications all down in July. In contrast the out of favour themes – Small caps, Value and Low volatility along with Staples, Utilities and Financials were all up. The largest trend reversal occurred in during the week of the 11th of July coinciding with the softer than expect CPI print and an increased likelihood of lower interest rates and a soft landing. Can the soft landing narrative continue to support greater breadth in global equity markets?
Figure 1: Sector and Style Returns in July 2024
Equity Concentration At Extremes
Equity concentration has been extreme in recent years and Figure 2 provides a long term historical perspective from 1926 to 2024. The level of equity concentration is at or near to levels seen in past extreme cycles. Historically these trends can persist for long periods of time but ultimately they move back to more normal levels. The mega capitalised stocks have benefitted form the AI theme and have seen continued upwards earnings momentum helping them reach and sustain lofty valuations.1
Figure 2: Extreme Market Concentration from 1926 to 2024
Average Market Cap - Top Decile (10%) relative to 5th Decile
As earnings are continually revised higher, the bar is raised for ever more impressive earnings beats. Nvidia is a classic example of a company that has seen extreme growth in sales but must generate ever increasing sales just to maintain similar rates of growth. Once the earnings momentum peaks the stocks with most expensive valuations are most at risk of a reversal.
As highlighted in Figure 3 Nvidia’s sales have increased from $5,000mn in Jan 2023 to $25,000mn in April 2024. The Jan-23 sales result surprised by +0.8%, the April-23 by 10.6%, the July-23 surprised by +22.8%, the next quarter it surprised by +13.8% the next quarter by +8.3% and most recently by +8.5%. It has become increasingly more difficult to generate higher growth rates from higher levels of growth and to meet increasing expectations. At the same time, the expectations for lower interest rates combined with a soft landing expectation improves the growth prospects for other companies.
Past performance is not a reliable indicator of future performance
Disclaimers regularly point out that “Past performance is not a reliable indicator of future performance” and Figure 4 provides some empirical evidence in support of this claim. Figure 4 provides a heat map of the Sector / Style return rankings in each calendar year form 2003 to 2023 and for the H1 2024. Rank 1 is the best performing sector / style and is the darkest green colour. Rank 16 is the worst performing sector style and is darkest orange colour. The changing colours from year to year highlights the varying performance of sectors and styles over the last 20 years. The key message is that best performing sector and styles in one year are often not the best performing sector / style in the next year. On average the correlation from year to year is a very close to zero. (+3.7%).2
The Bottom Line
Mega cap Technology and Communications with growth, quality and momentum have been the dominate themes in recent years. The July rotation away from these themes highlights the potential for other styles and sectors to outperform and is a timely reminder on the importance of diversification.