Is US tech the only game in town?

The below is an extract from our Q3 Asset Allocation outlook.

In 2023, the ‘Magnificent Seven’ stocks – Apple*, Alphabet*, Amazon*, Meta*, Microsoft*, Nvidia* and Tesla* – collectively rose 106%, accounting for more than half of the 22% rise in the S&P 500.¹

Remarkably, the same group seem to be repeating that feat in 2024, up another 35% on a market-cap-weighted basis, which would annualise for the full year at just short of another doubling in value.²

However, that headline hides growing dispersion in performance: of the seven names, only four have strongly outperformed the S&P 500 this year, with two underperforming and one outperforming only by a couple of percentage points. One, Nvidia, is seeing its advantage and importance to US and global equities stretch to what could be considered uncomfortable proportions. It’s up 166% year-to-date and has accounted for just over a third of the gain in the S&P in that time.

Will the rally broaden out?

This raises the question: can performance broaden out to the laggards that include, well, everything else? Europe is up just 6% year-to-date in USD terms, Japan 6%, the Russell 2000 is up just 1% and even the S&P 500 itself on an equal-weighted basis is up only 3%.³

For broadening out to occur, some combination of two things need to happen: US tech needs to underperform and/or the rest of the world needs to discover some independent upward impetus.

On the former, it should be noted that tech has, thus far, proven nearly infallible to monetary tightening, political dramas in Europe or fears of over-ownership. Neither are we yet at valuations that have historically represented bubble peaks. Nvidia* trades on a forward price-to-earnings (P/E) ratio of 45x earnings; in 2000, Cisco Systems*, the Nvidia of its day responsible for the physical architecture of the burgeoning internet, traded up to 110x earnings.

It's getting very crowded in here

However, the extent of the crowding into winners is becoming notable: the momentum index – the strategy of buying winners and selling losers – is close to an all-time high relative to the S&P. And inevitably, when momentum reversals occur, they tend to be painful and self-fuelling processes.

Nvidia’s quarterly results have become critical market events, superseding some of the major economic data releases (if we look at the size of implied market moves in the derivatives market).

To add fresh capital to US tech, one has to have a high level of confidence in one company’s ability to execute and dominate not just in the short term, but over the medium term too.

Comeback kids

And what of the rest of the world’s ability to help itself? A fresh bout of political noise in Europe is perhaps the last thing that was needed. But if US and tech is a crowded position where expectations represent a high hurdle, the rest of the world is the opposite.

So, some combination of possible stimulus from China, a new and stable government in the UK and a polarising but perhaps hamstrung new government in France (which could be limited in its ability to pass any legislation, good or bad) could lead to outcomes in the rest of the world that are better than is captured in prices.

If non-US sentiment ticks higher, or if the AI revolution hits a bump in the road, a subsequent momentum reversal could be disruptive, something which continues to make a degree of diversification (i.e. spreading the equity risk across regions in a more balanced way rather than holding concentrated position in US equities alone) more than prudent.

As our colleague John Roe has described, diversification is not without psychological cost: the benefit of reduced exposure to price fallers has the flipside of a lack of concentrated exposure to the gainers.

But as part of a clear investment framework, we believe this is a price worth paying.

The above is an extract from our Q3 Asset Allocation outlook.

*For illustrative purposes only. Reference to a particular security is on a historic basis and does not mean that the security is currently held or will be held within an LGIM portfolio. The above information does not constitute a recommendation to buy or sell any security.

1. Source: Bloomberg, as at end-2023.

2. Source: Bloomberg, as at 14 June 2024.

3. Source: Bloomberg, as at 9 July 2024.