Market Review
Most global equity markets rallied strongly during the first half of 2024. In the US, the S&P 500 was up 15.6%, with its growth once again super charged by the performance of a handful of tech stocks. Amazingly, the market capitalization of the three largest US tech stocks is now equivalent to that of the combined valuation of all publicly traded companies in either Europe or Asia. The Dow Jones average gained a more modest 4.9% and the broad US bond index fell by 1.3%. Outside of the US, emerging markets were up by 7.7%, Europe increased by 6.3% and Japan rose by 6.5%, all in dollar terms.
Through July 15, our core strategy, Polygon Global Growth, which is diversified by both geography and asset class, was up 11.5%.
On the economic side the US, is starting to see signs of a slowdown, as GDP growth has fallen from 4% at the end of last year to roughly 2%. Not surprisingly, inflation has also begun to decelerate and is now within sight of the FED’s 2% target. Although employment data remains robust, fissures are starting to appear. The unemployment rate has been ticking up, as are credit delinquency rates. Job openings, a useful leading indicator, are beginning to decline, and are roughly half what they were two years ago.
Clearly, consumers are starting to moderate their spending patterns as they burn through some of their post COVID savings. All of which increases the likelihood of at least one, and probably several, interest rate cuts by the FED before the end of the year. Outside of the United States, several European Central Banks have already started to cut rates, further increasing the pressure on the FED to do so. In Japan, with the Yen at lows not seen since the mid-eighties, the Central Bank of Japan is poised to move in the opposite direction.
While the global macroeconomic news remains generally positive, a number of near-term question marks hover over the world economy. The first of these is political risk. The increasing likelihood of a Trump victory in the US raises the specter of potential disruptions in America; witness recent events. In Europe, the results of the June/July French elections cloud the composition of the government, while in the UK, the prospect of a Labor Government has unsettled some investors. Additional concerns are the deteriorating situation in both Ukraine and Palestine. All of these factors combined have contributed to a level of political nervousness which has rarely been seen across the developed world. While individually none of them may have a huge short-term impact, over time —they may well do so. Certainly, markets and capital do not thrive on these kinds of uncertainties.
Underpinning these issues is the growing movement towards nationalism and its corollary: de-globalization. While it may make political sense, from an economic perspective many of the industrial policies being contemplated are likely to be counterproductive. Subsidies and tariff barriers, both of which represent a tax on consumers, as well as severing global supply chains, which will reduce economies of scale, are distortions that will make the global economy less efficient. Similarly, imposing restrictions on the free movement of capital, and to some extent people, will have a negative impact on economic growth.
Returning to the capital markets, I wanted to address several anomalies which may also represent opportunities. The first of these is the valuation of US stocks compared to the rest of the world. As noted above, with the recent out performance of US equities, the valuation gap between the US and many other countries is large and growing. For instance, current price to earnings ratios in the US are over 21 vs less than 13 in other developed countries—a gap which has grown over 50% over the course of the last decade. Similarly, price to book ratios in the US, at 3.7, are over twice the average of the OECD (1.6) a difference which has increased by 130% in the last ten years. Certainly, the outstanding earnings growth rate in the US tech sector accounts for some of these differences, but even taking that into account, the valuation differences are excessive, suggesting that in addition to the diversification benefit, there are many opportunities to profitably invest outside of the US. Your portfolio continues to have a substantial exposure to non-US stock markets, a stance we intend to continue.
Within the US, two other anomalies exist which stand in marked contrast with the long-term data. The first of these relates to value-oriented stocks, which have historically outperformed growth stocks over extended multi decade periods. However, over the past several years, value strategies have done less well, primarily because of the concentrated rally in tech stocks mentioned above. Although until recently there have been few signs of reversion towards the mean, history suggests otherwise. In fact, over the past several weeks value stocks have begun to close the gap.
The disconnect between small and large company stocks in the US is even more glaring. Again, historically, smaller companies have outperformed, but in recent years the opposite has occurred. As long-term investors, we believe that the this is an example of what has been called “recency bias”, and that the arguments underlying the outperformance of small cap companies still pertain. They are nimbler, their employees often have more skin in the game and they are more entrepreneurial. In anticipation of a potential FED easing, the last month has seen a substantial rally in small companies’ stocks. We believe our portfolios are well positioned to benefit from both of these trends.
I hope this brief overview will provide some sense of how we see the current market environment, and of how we are seeking to take advantage of mispricings where we see them. We intend to continue on our current course, maintaining a disciplined and diversified process, with the expectation that, over the long term, this will generate, strong, positive risk-adjusted returns.