“Whether it’s Snoop Dogg at gymnastics or an Olympian providing an exclusive first-person perspective as they achieve their lifelong dream, ‘Primetime in Paris’ will be must-see TV every night.” – Rob Hyland, Primetime Producer, NBC Olympics
As the world eagerly awaits the upcoming Olympics, we at Verger can’t help but find parallels between the Olympic Games, the athletes, and the world of investing. In these endeavors, it’s all about preparation, discipline, training, and the successful execution of smart strategy.
This summer’s Olympic Games across France will feature over 40 sports – including breaking, a dance sport that is brand new to the games, and beloved events such as gymnastics, swimming, and basketball. While the latter receive primetime spots in the U.S. viewing schedule, there are a wide range of athletic talents on display, and more than a few niche events adored by global fans. Whether it be badminton, sprinting, table tennis, or race walking, the athletes competing are at the peak of their careers and pursuing the same gold, silver, or bronze medals. For Olympians, as with investors, the glory shouldn’t come from the attention, the media coverage, or the celebrity appearances, but rather the results of the vast time and effort spent in preparation.
Indeed, for Olympic athletes and investors alike, the journey to the podium is marked by countless hours of practice, relentless discipline, and a steadfast commitment to long-term goals. Building a robust athletic or investment strategy requires patience, a disciplined routine, and the ability to adapt to unexpected setbacks.
Once again this quarter, we saw a continuation of recent equity market trends, where U.S., large growth stocks led global markets. While the S&P returned +4.3%, growth stocks returned over twice that amount (+9.6%) and value stocks actually declined during the quarter (-2.1%). For fixed income, investment-grade bond returns were flat, while high-yield bonds gained ~ 1%. Within real assets, commodity returns were positive, led by industrial and precious metals.
As with popular Olympic summer events such as swimming grabbing most of the primetime viewing fanfare, this quarter continued to see a small group of U.S. growth companies taking up the space in the spotlight. However, even within the growth style, equity returns have been extremely concentrated over the first six months of 2024. Looking at the return of the S&P 500, for example, we see that each of the following three segments contributed approximately 1/3 of the total return: (1) one stock – Nvidia; (2) five other stocks – Alphabet, Amazon, Apple, Microsoft, and Meta; and (3) the remaining 494 stocks in the index. In other words, only six stocks generated 2/3 of the overall return.
FY 2024 = line pattern fill Q2 2024 = solid bar
Source: Bloomberg
To illustrate just how unusually concentrated U.S. equity returns have been, the chart below shows the return difference for the first six months of each year, from 1990 – 2024, between the cap weighted S&P 500 and the equal weighted S&P 500. As noted, these are the biggest differences since at least 1990.
Source: Bloomberg
U.S. growth stocks continue to be the main driver of recent market returns and, as we’ve pointed out in recent commentaries, they seem to be the primary (or even the sole) focus for many investors. At Verger, we believe that not all stocks are worthy of the podium, but that faster growing companies, all other things equal, should trade at a premium to slower-growing companies. The key question is: how much of a premium?
The chart below shows forward Price/Earnings ratios (as of the end of June) compared to 10-year averages for various U.S. equity segments. As you can see, over the last 10 years, growth stocks have traded at an average P/E of ~ 21, which is higher than all other market segments, including value stocks, whose 10 year P/E is ~ 15. Once again, we believe this makes sense: faster growing companies should command a premium valuation. However, the chart shows that growth stocks are currently trading at a much higher P/E level (~28) than their (already premium) long-term average.
Is this extreme premium justified? Or are, perhaps, these equity returns ahead of their underlying fundamentals? The chart below may answer this question. Over the last ~ 18 months, the vast majority of U.S. equity returns have not been from earnings or dividends, but, instead, from investors paying higher valuations.
Source: The Daily Shot, 5/22/24
Within the technology sector in particular, valuations (based on Price/Sales) have almost doubled since late 2022, and, as the chart below demonstrates, now trade at all-time highs.
So, here’s where we stand at Verger: we don’t believe these recent trends are sustainable. While valuations aren’t typically a good predictor of short-term returns, the price you pay for an asset is a key determinant of your long-term returns. A key question we should all ask ourselves is this: how much of the good news for stocks (especially popular growth names, including the “Magnificent 7”) is already reflected in prices? We think the answer is “quite a bit” and the resulting potential for investor disappointment going forward in many growth stocks could be high. To paraphrase Warren Buffett: you pay a high price for a cheery consensus.
In the Olympic Games, there are exciting competitions across athletic events. In the markets, there are interesting opportunities to buy good companies at reasonable valuations (or even discounts) across sectors.
With equity returns so concentrated, we also tend to wonder if any investor disappointment around the small group of growth stocks could trigger a reverse in the current narrow rally. Of note, we’ve seen exponential growth in not only 0DTEs (Zero Days to Expiration Options), but also of 3x levered ETFs for single-name stocks, such as Nvidia. These are examples of investor behavior that could be considered signs of market exuberance, which often occur in the latter stages of a market rally.
Just as athletes must adapt to different conditions, competitors, and sometimes unexpected events, markets are dynamic, and we seek to take advantage of perhaps underappreciated opportunities – akin to the more niche Olympic events (rhythmic gymnastics, anyone?).
While many investors continue to focus their attention on a handful of flashy names, we continue to find attractive opportunities in less mainstream market segments, including: Japanese equities, biotech/pharma, reinsurance, closed-end funds, mortgages, and idiosyncratic investments in certain emerging markets.
One area of opportunity to call out within public markets is the consumer staples sector, which is typically referred to as a defensive sector given its historical resilience throughout market cycles. Fund flows data show us that investors have been moving away from defensive sectors towards technology and other high momentum sectors. As the chart below shows, index weightings to defensive companies have fallen to near all-time lows, even below traditionally cyclical sectors.
We’re noticing that certain segments within consumer staples offer not only attractive valuations (on both an absolute and relative basis) but also high-quality characteristics (e.g., high operating margins, healthy balance sheets, high returns on capital).
We’ll continue to watch for this kind of opportunity – one that requires breaking away from the pack at the beginning of a mass start race (mountain biking, anyone?) and keeping our eyes on the rough terrain.
For many Olympians, the journey to the podium is measured not in months or even years, but in decades of unwavering commitment. Each training session, competition, and sacrifice is a step towards the ultimate goal of Olympic glory.
Just as athletes endure setbacks and challenges on their path to the Olympics, investors must navigate market volatility, economic downturns, and unexpected financial events while remaining focused on long-term objectives. At Verger, our all-weather and antifragile investment approach is designed with this commitment to the long-term at the forefront. We don’t just expect market turbulence – we’re prepared for it.
Since the last summer Olympics, which were four years ago in Tokyo, there have been numerous, often unexpected, market “cycles.” To jog the memory: first, there was the COVID-induced equity market selloff and subsequent rallies in 2020 and 2021. Then, there was the equity and bond market selloff during 2022, followed by the strong equity market rally, led by growth and AI-related companies, over the last 18 months. We are confident that over the next four years, there will continue to be unexpected economic and financial events that result in similar market swings. We strongly believe that Verger’s strategy is well suited to weather changing market conditions and produce attractive, long-term risk-adjusted returns going forward.
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