Is this the start of the Great Rotation?
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.
Figure 3: Nvidia Sales Growth & Sales Surprise
Source: Factset as of 19 July 2024. This information should not be considered a recommendation to invest in a particular sector or to buy or sell any security shown. It is not known whether the sectors or securities shown will be profitable in the future.
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.
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Bruce is Head of Active Quantitative Equity - Australia, for State Street Global Advisors. He has over 20 years' experience, covering Australian and global equites, long and short equities as well as global macro strategies.
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(1)Technology Earnings revision EPS NTM +24% in the last 12mths, +6% in the last 3 months, +2% in the last 1 month. Valuations relative to last 23 years at 94th Percentile. As at 19 July 2024.
(2)Only 3.7% of the co-movement in last years returns can explain co-movement in the next years return.
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The views expressed in this material are the views of Bruce Apted, Head of Portfolio Management Australia, Systematic Equity - Active Team through the period ended 23 July 2024 and are subject to change based on market and other conditions. The information provided does not constitute investment advice and it should not be relied on as such.
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1 fund mentioned
Head of Portfolio Management – Australia, Active Quantitative Equity
State Street Global Advisors
Bruce is Head of Active Quantitative Equity - Australia, for State Street Global Advisors. He has over 20 years' experience, covering Australian and global equites, long and short equities as well as global macro strategies.
Head of Portfolio Management – Australia, Active Quantitative Equity
State Street Global Advisors
Bruce is Head of Active Quantitative Equity - Australia, for State Street Global Advisors. He has over 20 years' experience, covering Australian and global equites, long and short equities as well as global macro strategies.
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