Market Pulse
Friday, July 26, 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:
Cyril (CIO), and the rest of the Sidekick team.
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.
Historically speaking, small-cap stocks have generally outperformed large-cap stocks. Between 1972 and 2023, US small caps generated annualised returns nearly a full percentage point higher than US large caps. [1]
This outperformance shouldn’t be surprising. Smaller companies are typically riskier than bigger ones, meaning their share prices are subject to greater volatility and drawdowns. As a result, investors usually demand a higher risk premium for holding small caps.
But in the recent past, this pattern has gone missing in action, with market performance increasingly driven by mega-cap companies. For the first half of 2024, more than half of the S&P 500’s entire gain was driven by just four large tech stocks, with nearly 40% of the index posting negative returns. [2]
A sharp rotation this month, though, indicates that the tide might finally be turning for small caps. As of the time of writing, the Russell 2000 Index of small-cap stocks has climbed by about 8% since the start of July. Over the same period, weak performance from index leaders has led the S&P 500 to post negative returns.
As we enter earnings season, the primary factor influencing this rotation appears to be diverging earnings growth expectations between small and large-cap stocks. Analysts expect companies in the Russell 2000 to post an 18% jump in second-quarter profits, which should snap a multi-year streak of consistent earnings declines. [3] Profits at most S&P 500 firms, meanwhile, are projected to fall slightly.
Several additional factors are also helping to supplement this earnings divergence. On the back of cooler inflation data, the odds of a near-term Fed rate cut have jumped, a bullish factor for small firms who tend to carry more debt. [4] Morgan Stanley analysts, meanwhile, pointed to hedge funds covering short small-cap positions as a technical factor boosting the rally. [5]
Still, the rotation hasn’t been enough to overturn the recent dominant performance of large caps. The year-to-date return for the S&P 500 remains more than 5 points higher than the Russell 2000. Overall, however, we see reduced concentration and wider breadth as positive signs that could lead to more sustainable market growth.
Research from asset manager Blackrock points to the growth of a relatively novel trend in the ETF space: active management. [6] While the ETF wrapper has been almost synonymous with passively managed index products, investors are now showing an increasing appetite for active variants.
Active ETFs have absorbed 22.4% of all ETF inflows so far this year, up from just 7.3% as recently as 2020. And Blackrock doesn’t expect this trend to slow down, forecasting global active ETF assets to hit $4 trillion by 2030.
The return of active management might seem like a surprise, especially given the seemingly unstoppable growth of passive strategies. [7] But over the past few years, the market environment has shifted dramatically. Interest rates have gone from zero to 5% with almost unprecedented speed, and volatility has returned to financial markets with force.
These trends are contributing to increased “dispersion” in equities, meaning that the movements of individual stocks are less correlated with each other than they once were. [8] When capital is cheap and rolling over debt is easy, the fortunes of companies making bad decisions may not differ much from those of companies making good decisions. But as Warren Buffet once quipped, you only find out who is swimming naked when the tide goes out.
This growing disparity of business outcomes (and the resulting dispersion in share prices) is likely behind the renewed interest in active managers and stock pickers. Active managers aren’t necessarily more skilled in a risky environment. Instead, it’s the risky environment that allows for greater expression of the skill of an active manager, as one quantitative analysis from Morgan Stanley put it. [9]
The trillion-dollar question, then, is whether a high-dispersion regime is here to stay. In the near term, investors certainly expect it to. The Cboe dispersion index, which measures anticipated dispersion in the S&P 500 over the next 30 days, is currently at its highest level in more than a year. [10]
Over the long term, the continuation of a high-dispersion environment will largely depend on future interest rate changes. But with the global economy proving more resilient than expected and lingering concerns over a resurgence in inflation, we don’t expect to see significant changes in interest rates for some time. That’s good news for active managers – and the investors that back them.
This week saw a wave of earnings, with companies posting decidedly mixed results. Here, we’ll look at how a few of the Flagship portfolio companies fared.
Tesla’s revenues fell by a modest 2% YoY between Q2 2023 and Q2 2024. On the back of a shrinking sales margin, though, profit declined by a more substantial 45% YoY. [11]
Tesla’s margin miss is largely the result of the company’s efforts to increase sales by offering discounts on their existing lineup. Despite fierce price competition in the EV space, Tesla hasn’t launched a new low-priced option in recent years. Recent comments from Elon Musk, though, indicate that could be changing soon. [12]
Because Flagship is underweight Tesla compared to our benchmark, we were relatively well-positioned for an earnings miss. Although it may seem counterintuitive, Tesla’s declining share price in the wake of the earnings report made a positive contribution to Flagship’s comparative performance.
Life sciences company Danaher posted a significant earnings beat, with revenue and profit about 2.8% and 9.3% higher than expected, respectively. While both figures did register a decline YoY, the better-than-anticipated performance led to a significant jump in the share price.
We were encouraged by the results and strong guidance, particularly in Danaher’s bioprocessing and molecular diagnostic testing business lines. [13] Danaher is a high conviction holding in Flagship, and the “earnings beat” on Tuesday helps show why.
LVMH earnings were slightly disappointing. H1 revenue came in at €41.7 billion, a 1% year-on-year (YoY) decline and below analyst expectations. H1 profit fell by a more significant 8%, although this decline was exacerbated by currency effects. [14]
After years of powering industry growth, China’s demand for luxury goods appears to be starting to falter. LVMH Sales in Asia (excluding Japan) fell by 10% YoY.
Earnings for Alphabet, Google’s parent company, were much more positive, with the company beating both revenue and earnings estimates. Ad sales, which drive most of Alphabet’s income, rose 11% YoY, with overall profit climbing about 28%. [15]
While the market’s reaction was moderated by higher-than-expected capital expenses, the results should help allay investor concerns about Alphabet and artificial intelligence. While LLMs are a competitor to Google search, they also require tremendous cloud computing power, helping drive Google cloud revenue 29% higher YoY.
Visa’s earnings came in below analyst expectations, the first time the company has missed estimates since early 2020. [16] Still, headline figures were strong, with net revenue and net income climbing 10% YoY and 17% YoY, respectively. [17]
Cooling payment volume data did leave some room for concern, especially among low-spend consumer segments in the U.S. Anticipated interest rate cuts later this year, though, might serve to support a resurgence in spending.
2: JPMorgan
4: Bloomberg
5: Bloomberg
6: Blackrock
7: CNBC
10: CBOE
11: Tesla
12: The Verge
13: Yahoo Finance
14: LVMH
15: Alphabet
16: Reuters
17: Visa
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