Over the past few years, a relatively small number of shares have driven a disproportionate amount of the return from the S&P 500.
To put this into perspective, in 2023 the S&P 500 returned 26.29%. The Magnificent Seven (just seven companies in an index of approximately 500 companies) accounted for 62.2% of that return. Without those seven companies, the return from the index would have been only 9.94%.
That is an extraordinary level of concentration.
Our managers have deliberately chosen not to chase this theme aggressively because they believe the risk has increased as prices have risen.
What is the concern with tech, AI and semiconductor stocks?
Our managers are not saying that AI is unimportant. Far from it. AI may change the world. However, think back to the dot-com bubble. The internet went on to fundamentally change the way we live and do business. The problem was not the technology. The problem was the price investors were prepared to pay for companies associated with it. Expectations became so high that when reality failed to meet them, share prices collapsed. Some companies recovered, but many disappeared altogether.
That is the concern today.
Using an analogy, if a house on your street is worth R5 million, why would you pay R10 million for it?
Our managers believe a similar risk exists in parts of the global technology market. Rather than paying increasingly high prices for what has already performed exceptionally well, our managers are finding opportunities elsewhere. For example, selected technology companies such as JD.com, where valuations are considerably lower than many of the fashionable US technology shares.
So where are they investing?
They have been increasing their exposure to high-quality global businesses whose share prices have not participated to the same extent in the recent excitement. These businesses are trading at unusually attractive prices. In other words, good businesses at discounted prices. They are financially strong businesses with durable earnings, strong balance sheets and competitive advantages that they believe will be better placed to withstand more difficult economic conditions.
Our managers are mindful that markets have not experienced a severe global recession for some time. They therefore do not want portfolios whose success depends on one fashionable theme continuing indefinitely. This does not mean these companies cannot fall in value. It means the portfolio is being constructed with the possibility of tougher conditions in mind rather than assuming that recent trends will simply continue.
Think of companies such as Visa, Mastercard and London Stock Exchange Group. These are established businesses with strong competitive positions, recurring revenues and services that people and businesses continue to use through different economic environments.
The important point is valuation.
It is also why periods of disappointing performance for these shares can sometimes sow the seeds of future outperformance. The best opportunities rarely arrive when everything looks safe and obvious.
Why are we comfortable?
We are comfortable with our managers’ positioning because we understand what they are doing and why.
They are refusing to chase an expensive part of the market simply because it has performed well. Instead, they are using the opportunity to increase exposure to quality businesses at valuations they believe offer better long-term return potential.
Sometimes the period that feels most uncomfortable is precisely when some of the best long-term opportunities are being created.