Market Pulse
Friday, October 25, 2024
Welcome to this week's Market Pulse, your 5-minute update on key market news and events, with takeaways and insights from the Sidekick Investment Team.
Our three stories this week:
1. Doom & Gloom: Consumer Confidence is Lagging
2. Breakup Drama: Google’s Antitrust Case
3. UK Small Caps: An Existential Threat
It’s important to note that the content of this Market Pulse is based on current public information which we consider to be reliable and accurate. It represents Sidekick’s view only and does not represent investment advice - investors should not take decisions to trade based on this information.
Taking a look around the global economy, you’d be forgiven for feeling optimistic. While there are certainly some areas of concern, inflation is cooling, global growth remains positive, and financial assets continue to perform well. Despite all this, however, recent measures of business and consumer confidence show that most people aren’t very optimistic at all.
The Tiger US Index, for instance, which tracks economic confidence for both businesses and households, recently registered a lower reading than in the depths of the Covid pandemic. The situation is even worse in China, where the same index has been stuck in significantly pessimistic territory since 2022.
Other measures corroborate these readings. In the US, the widely-followed Consumer Confidence Index recently registered its biggest one-month decline in three years. In the EU, the Economic Sentiment Index continues to track below its long-term average, while business confidence in Germany has fallen for the past five months straight.
Historically, investors have kept a close eye on confidence measures like this due to the risk of self-fulfilling economic prophecies. As the logic goes, if people expect the economy to get worse, they’ll rein in spending today, leading to an economy that actually does get worse. Academic research, however, calls into question whether this logic really plays out in practice.
Pre-Covid studies on the predictive content of confidence surveys in the US and EU found that these measures offered little extra forecasting value when including traditional economic indicators. In other words, if confidence measures appear to predict economic conditions tomorrow, it’s only because they reflect economic conditions today.
Intriguingly, recent Fed research indicates that even this logical link may be faltering. Post-Covid, consumers and businesses appear to be exhibiting a persistently negative bias. This means that even if economic conditions are strong, confidence measures may be weak.
What does this all mean for investors? In the past, confidence measures may have been useful to the extent that they summarised economic conditions, even if they weren’t very predictive on their own. If confidence measures have ceased to summarise economic conditions, however, we should be wary of placing too much importance on their readings.
The courtroom drama surrounding Google’s antitrust case continued last week, with a federal judge temporarily blocking the implementation of a ruling that would have forced the company to open its Android app store to more competition. While a court ruled that Google is an illegal monopolist back in August, final consequences have yet to be determined, with a remedy trial set for April 2025.
Despite the antitrust case, we continue to hold Google’s parent Alphabet in Flagship and remain confident in the stock as an investment. One of the main reasons for this is the company’s attractive valuation relative to peers in the Magnificent 7. Alphabet currently trades at 18.5x to next months’ estimated earnings, compared to 32x, 29x, and 24x for Apple, Amazon, and Meta, respectively.
Another reason is Alphabet’s strong underlying business performance. The company has exceeded earnings expectations for the past four quarters straight. In addition, Alphabet issued dividends for the first time this year, demonstrating an ability and willingness to return capital to investors.
Despite this, Alphabet’s performance has lagged broader tech indexes this year, largely thanks to the threat of the antitrust lawsuit. Judging by the US government’s history of antitrust cases, however, we think investors have less reason to fear than they might expect.
The most headline-grabbing remedy, a complete breakup of Alphabet, seems an unlikely outcome. Breakups are rarely imposed, with the most recent ones being Bell Telephone System in 1982 and Standard Oil in 1911. The most directly comparable case, when the US government accused Microsoft of being a monopolist in 2001, ended without a breakup.
Instead, we anticipate softer remedies, potentially including the divestment of a few subsidiaries, the banning of exclusive search contracts, or the modification of other business practices. In fact, it’s not entirely clear that a breakup of Alphabet would be bad news for investors as the value of different parts of the business gets crystallised.
Ultimately, Alphabet’s antitrust case does introduce risk to the stock. We think that the risk-reward tradeoff, however, is significantly skewed to the upside.
By now, the challenges facing UK equity markets are well-established. A recent report from think tank New Financial, however, lays bare just how urgent these problems are, especially for the UK’s smaller companies.
According to the report, small cap UK stocks face an ‘existential threat,’ with their numbers shrinking rapidly in recent years. Over the past two decades, some 600 companies with market caps of less than £1bn have delisted from public markets. The problem has been most pronounced in the UK’s junior market, the Alternative Investment Market (AIM), where the number of listed companies is at its lowest level in 20 years.
The problems associated with this trend are twofold. For investors, a lack of small cap stocks limits high-potential return opportunities (the AIM market has produced annualised returns of 7.4% over the past 25 years, in line with the S&P 500). For small cap companies themselves, delisting from public markets makes raising capital to fund growth more challenging.
There are no simple solutions to this problem. While asset manager abrdn has argued for removing the stamp duty on non-FTSE 100 shares, it’s not clear this would seriously help the situation – the AIM market is already exempt from the levy. Proposals to mandate UK pension funds to increase domestic investments, meanwhile, have met stiff resistance.
While there may be no catch-all solutions, we do believe that incremental changes can help improve the situation. As we have argued in the past, regulatory rules should be updated to make it easier for investors to access expert guidance. Simplifying the ISA market and offering tax breaks for domestic investment are also viable options. What is increasingly clear, however, is that the current situation is untenable. The need for new policy is more urgent than ever.
Please remember, investing should be viewed as longer term. Your capital is at risk — the value of investments can go up and down, and you may get back less than you put in.
