Quarterly Investment Review – Q3 2023
“The market is still dominated by investors that either will not (index funds), cannot (untrained novice investors) or chose to not (valuation indifferent prof. investors) have valuation as a cornerstone of their investment process.” David Einhorn
After the turbulence in the Spring when several banks collapsed, including Credit Suisse, equity markets recovered steadily helped by easier liquidity conditions, resilient economic data, a perceived peak in inflation and reasonable profit growth. By the end of September, the S&P500 was up 11% and the MSCI World Index was up 9.6%. However, these returns are misleading. The strong performance has been generated almost entirely by seven stocks (Apple, Microsoft, Alphabet, Amazon, Tesla, Meta and Nvidia). These stocks are up on average 91% and excluding them the indices are only modestly positive. The size of these companies is astonishing. Collectively their market cap equals about 40% of US GDP or 10% of global GDP. Apple and Microsoft’s market cap would place them in the top ten of the world’s largest countries by GDP. For example, Apple’s market cap reached $3 trillion, comparable to the GDP of India, the UK or France. Nonetheless with the market recovering so strongly since the Spring risk assets are now more sensitive to downside surprises and more caution is warranted. In particular, if the view that inflation is settling back down to pre-Covid levels is undermined, then both bond and equity markets would react poorly. Inflation has fallen due to lower commodity prices and supply chains stabilising, but a further fall is more likely to be caused by lower demand thus eroding company profits. At the end of the quarter the oil price started rising, and along with some large wage increase settlements, inflation may stay higher for longer. If this continues there is likely to be more pressure on the highly valued areas in the market, including the mega cap stocks.
Since early 2022 the world has undergone one of the sharpest interest rate rises in history. Following a long period of near zero rates, they have risen, in the case of the US, by 5.25% since March last year. Higher rates raise several concerns. The lagged effects of significant interest rate rises will burden the economy because of the higher financing costs. Many mortgage holders, businesses and investment funds took advantage of the cheap financing available when interest rates were low, and are now facing the reality of much higher rates as their loans are renewed.
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