Blog: You, us, everyone

In contrast to last year when multiple sectors performed (the leaders were energy, materials, financials, and industrials), this year just two sectors (technology and consumer staples), are up. More importantly, market’s performance is coming from a handful of companies. 

One important fact is that the top 10 mega-cap companies in the S&P500 represent now about 35 % of the market cap while 490 companies represent 65%. The buying spree of these 10 top-rated companies occurred, despite their loft valuations (average PE is 66 for the top three companies), on the optimism around broader use of technology, and specifically artificial intelligence. Because AI is expensive, it is driving inflation in the short-run, and this development is earnings recession supportive. 

In the event such conditions continue to prevail, the question of maintaining an underperforming, but well diversified portfolio needs to be addressed. The point here to retain is that our base-case scenario continues to forecast an annual return of about 5% for the S&P500, which is just about 200bp above the risk-free TB. While an active approach to a diversified portfolio may reduce some of the downside when markets fall, it will though not capture the upside. Therefore, investors are recommended to seek opportunities in other markets such as Europe or Asia where the average PE is around 12 to 15 for the broader market and where broad opportunities do exist.

Here are some broader views on the US equity market and why running after past performance could add additional volatility to investor's portfolio:

• Valuations are high: Excluding technology stocks, the median P/E is about 18x and equity risk premium is low, i.e., just about 2%
• Earnings: While the introduction of AI throughout the major industry segment is business supportive, it comes with a drag to earnings in the short-run. This comes on the back of other concerns which impact earnings negatively. They are: consumers being reluctant to buy high-priced products and services, dwindling consumer confidence, stubbornly high rate of inflation, and low wage growth.
• Interest cycle: The market is anticipating the FED to start a new interest cycle as soon as the 4th quarter 2023. Yet and according to our consolidated research, the FED is expected to start cutting rates only once the US economy enters a recession. Also, market participants expect the FED to cut implicitly on the back of inflation reaching 3 % any time soon. If so, something else would need to happen first, i.e., consumer spending much less or similar, either is a foreseeable event. 

What our broader considerations?

With the German economy having slipped into recession at the end of the 1st quarter of 2023, we continue to believe that the US economy may escape a hard-landing, yet the soft-landing scenario becomes less likely given the negative housing cycle, slow income and spending trends, a stable labor market, and the full impact of the banking crises still to be fully understood.

Given this, the possibility of a recession remains a key concern for asset allocators. The overall conditions in the US market, while they look brilliant from the outside, the real picture is slightly different. For instance, a spillover from the banking sector crisis is credit conditions to tighten, reducing borrowing facilities for corporations and individuals. By definition, the economy is highly dependent on fluent conditions in the credit market. In the event credit growth stagnates, then investments can’t be done, and ultimately it will result in job losses – the 2nd half of 2023 will most likely even more challenging than the 2022 and diversification into EMA and Europe might be an opportune move.