Reflecting on market developments during June and July, Mark Rimmer, Fund Manager in the Premier Miton Multi-Manager Team, examines why recent volatility challenged some of the year’s most popular investment themes and reinforced the importance of diversification.
Volatility in AI-related stocks is a reminder of the risks that can emerge when market leadership becomes too concentrated, argues Mark Rimmer, Fund Manager in the Premier Miton Multi-Manager Team, who believes diversification and valuation discipline remain crucial in an uncertain environment.
Despite a series of geopolitical ructions and conflict in the Middle East, global equity markets have, for the most part, performed strongly so far this year. Equity markets have, in part, been carried along on euphoria surrounding Artificial Intelligence (AI), with Asian markets, as exemplified by South Korea and Taiwan in particular, rallying strongly, also benefiting some segments of the US and Japanese markets.
For some time, we have been eschewing the momentum wave driving many such stocks higher. Therefore, we have had less exposure to most of these areas.
Since mid-June, concern has grown over the valuations of the US hyperscalers (such as Amazon, Alphabet, Apple, Meta and Microsoft) and the Asian semi-conductor stocks (such as SK Hynix, Samsung and TSMC), and these stocks have given up much of their gains.
Even as some tech names have delivered good earnings results, the stocks have not always responded positively, especially if they have not met lofty expectations. Clearly, in many cases a lot of future promise is already in the price.
We believe it’s important not to get too carried away by the strong returns generated by such concentrated leadership. Although we have far greater diversification than standard equity indices replete with such risky exposure, we have also been deliberately reducing the areas of greatest risk.
This has seen us reduce Emerging Market and Asian holdings heavily allocated to the popular markets of South Korea and Taiwan that have been buoyed by their semiconductor behemoths. This has helped insulate us from the worst of the market pull-backs during July.
Amidst the extreme volatility seen in semiconductor stocks, which were off sharply in July, though still well in positive territory for the year to date, the UK, having been a laggard thus far, was one of the strongest performing equity markets in July.
The UK has been beset for some time over political uncertainty, which has somewhat unnerved investors, but towards the end of July, the UK saw the arrival of its seventh Prime Minister in ten years. Having masterminded an uncontested coup, Andy Burnham entered Downing Street with a need to maintain fiscal discipline.
This is an area of focus for bond markets as the higher cost of borrowing has again depleted the slim headroom that the outgoing Chancellor had maintained.
With his first few days seeing a drip-feed of announcements for cost-of-living support and new spending pledges, it is likely that Andy Burnham, or his incoming Chancellor John Healey, will be required to prove their discipline in keeping UK government borrowing costs in check.
The market reception to both Andy Burnham and John Healey has been broadly favourable for now, with the latest opinion polls also confirming the ‘Burnham bounce’, but when harder decisions need to be taken, for example at the Budget on 28th October, it may be a different story.
However, in the meantime, investors have welcomed the UK’s improved performance, with small and mid-cap stocks, having lagged thus far, also joining in the rally.
While there has been much gloom evident in the news, with the overhang of conflict in both the Middle East and Ukraine, it is important to recognise that second quarter company earnings in the US and globally continue to impress.
Kick-started by the big US banks, corporate earnings continue to be resilient and exceed analyst estimates. As financial returns have demonstrated this year, the strength in corporate reporting has outweighed some softening of the economic outlook.
Robust corporate reporting has resisted the assumption that stock markets would remain more sensitive to unfolding geopolitical events. With conflict having escalated in July, reflected in the sharply higher oil price (though very recently the conflict encouragingly appears to be on pause, with oil prices giving up ground), the status of the ceasefire in the Middle East remains very unclear, and the blockade of the Strait of Hormuz still poses a major threat to global supply chains.
With oil prices heading higher in July, bond markers weakened. Early in the month the ECB kept rates on hold but did nothing to dispel the notion that they could be set to raise rates again fairly shortly. In the US and UK, Central Banks also kept rates on hold, but in contrast, while some voting members dissented for hikes, markets concluded that imminent rate hikes here were on pause, reassuring investors.
As markets continue to assess the persistence of the ‘Burnham bounce’, with the UK equity market performing well and providing a good level of income, volatility in global semiconductor stocks in the US and Asia continues apace, which brings to mind the tortoise and the hare.
Main image: background, blue, jeremy-thomas-E0AHdsENmDg-unsplash
