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CIO Update: Narrow footing on higher ground

  • Global equities up strongly in the first six months as AI mania trumps economic fragility
  • Narrow rally creates risks for tech stocks and passive investors given high index concentration
  • Valuations and macro uncertainty mean contrarian bargain-hunters likely to outperform

As we enter summer, global equities have delivered a sizzling 14.3% US dollar return over the first six months to recover most of 2022's losses (-18.0%). This highly respectable performance – currency weakness has helped NOK investors gain an additional 10 percentage points – has been achieved despite continued economic weakness and conflict in Ukraine, as well as several bank failures.

As I wrote about last month, the rally has been driven by a small number of large US tech companies that investors believe will benefit most from artificial intelligence (AI). The continued stellar performance of these 'surging seven' stocks has propelled the NASDAQ composite to its best first half return (+32%) for 40 years. Indeed, without these mega-caps growing a remarkable 40%-180% in just six months, the market return would be low single digits, as illustrated by the S&P 500 index.


Such runaway returns are even more remarkable considering interest rates have steadily risen this year as central banks continue to grapple sticky inflation. Tighter monetary policy has historically hindered growth companies but the septet have been so powerful that value stocks have lagged significantly year-to-date[1].

The rally's narrowness means that the US has unsurprisingly led the way in geographic terms, while European stocks have also performed strongly, helped by low valuations and rising earnings estimates. Norway unfortunately bucked the trend, falling 6.7% on the back of currency and energy sector weakness.

Emerging markets (+5.0%) have also disappointed so far, trailing developed ones (+15.4%) as China's COVID-recovery remains lacklustre. The headwinds from excess debt and a fragile property sector will likely require further government stimulus. More positively, the technology leadership of Taiwan and South Korea means both countries are benefitting from their prominent positions in the AI value chain, and with valuations still at reasonable levels, we expect this tailwind to continue.

SKAGEN's equity funds have performed well over the first six months with the majority delivering positive absolute returns and all either ahead of or in touch with their respective benchmarks. It is at times like these when markets appear distorted that our contrarian and price-driven approach tends to bear most fruit. You can read more about the funds and how their portfolios are positioned in the quarterly reports on our website.

Technology bubble 2.0

The market's strong first half performance inevitably brings higher risk, particularly given its slender foundations. I fear that we could see a correction when tech investors realise the need to apply higher discount rates to future earnings, particularly as valuations leave little room for disappointment. NVIDIA, for example, currently trades on a P/E over 200x – 72% wider than the start of the year and the same as Cisco before its share price collapse at the peak of the dot com bubble[2].

The concentration of US tech stocks in major indices means that passive investors face similar risks. The 'surging seven' are the largest constituents of the MSCI All Country World Index and together represent 16.5% of the global benchmark. Those tracking the S&P 500 index have a 28.3% tech weighting – a smidge below the sector's 1999 high of 29.2%. This has skewed the benchmark's P/E above its historic average and created an unsustainable valuation gap between the ten largest companies and the rest.


No one knows if history will repeat but anything close to the dot-com bubble when the S&P 500 index lost 46% and the NASDAQ Composite dropped 80% in two years would clearly hurt. The best way to avoid similar pain is to focus on valuations which remain the safest way to generate decent returns and manage risk.

Segments that have underperformed the AI bandwagon, for example emerging markets, small caps, value and real estate, offer much better value that should also help to soften any market correction. The current environment also highlights the value of unconstrained mandates in giving our fund managers the flexibility to find the best opportunities across geographies, sectors and company sizes. 

An uncertain macro environment further validates the need for careful stock selection. Consensus forecasts show inflation slowing over the coming quarters but the path to achieving central banks' 2% target is unlikely to be short or smooth, particularly as employment and consumer spending remain resilient. This means that interest rates will probably also stay higher for longer than most economists expect, favouring value over growth. 

This year SKAGEN celebrates our 30th birthday and three decades of investing have taught us that trying to predict the future accurately is impossible. Our clients' interests are better served by focusing on finding companies that offer the best long-term returns weighed against the risks they face across a range of scenarios. By sticking to this common-sense approach, I believe that our funds will continue to deliver uncommon returns for unitholders over many more years to come.

All figures in USD as of 30 June 2023 unless stated.

[1] MSCI ACWI Value +2.7%, MSCI ACWI Growth +23.6% (both in USD as at 30/06/23).
[2] Source: Bloomberg, as at 10/07/2023

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