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the author is Richard Bernstein Advisors CEO and Chief Investment Officer
Experiencing the ups and downs of a seesaw is one of many childhood joys. But sitting on the fulcrum of a seesaw is no fun at all, because it doesn’t move relative to the levers at either end.
The stock market in the past few years has been like a seesaw, and the “market” is the fulcrum of this seesaw. Overall market statistics mask significant performance differences at either end of the seesaw.
Technology, cryptocurrency, innovation, disruption, artificial intelligence and other high-profile investments are on one side of the see-saw, while everything else in global stock markets is on the other.
Market rotations over the past few years have mimicked our see-saw picture. In 2020, the exciting side of see-sawing has risen. Technology, consumer discretionary and communications were the three top-performing sectors. Cryptocurrencies have returned hundreds of percent, with seven large tech-related companies, now known as the Magnificent 7, more than doubling their returns.
The see-saw is starting to level off in 2021, while everything else in the world is headed higher in 2022. In 2022, 70% of non-U.S. markets will outperform the U.S. in U.S. dollar terms. The broad-based US market index Russell 2000 outperformed the US market Nasdaq 100 by 12 percentage points and outperformed the Magnificent 7 Index by a decisive 25 percentage points.
So far in 2023, the seesaw has swung dramatically in the other direction. Despite Bitcoin’s recent correction, it is still up over 50%. Communications, technology and consumer discretionary were once again the best-performing sectors, leading the way.
On top of that, the number of stocks on the rising side of the see-saw has shrunk significantly. As of August 31, the share prices of the Magnificent 7 Index were up 95% this year, and these 7 companies alone will contribute up to 71% of the S&P 500 Index’s 2023 gains.
Research I conducted in the early 1990s with colleagues at Merrill Lynch showed that when profit cycles decelerate, financial markets become “Darwinian” and leadership shrinks. Survival of the fittest describes an environment in which investors are attracted to fewer and fewer companies that can consistently grow profits.
However, when profit cycles accelerate, markets expand because lower-quality, more cyclical companies have greater operating and financial leverage. To use a cliché metaphor, a rising tide lifts all boats.
According to the framework, the unique performance of the “top seven” companies in 2023 implies extremely dire predictions for corporate profits, the global economy, and even the overall survival of enterprises, with only seven of them able to achieve growth. There are clearly more than seven growth stories across global equity markets, so there may be many overlooked opportunities on the other side of the seesaw.
U.S. small-cap, European, Japanese, Chinese and U.S. themes focused on real productive assets and the rebuilding of U.S. manufacturing capabilities all appear to be particularly attractive.
Artificial intelligence is not included in the list of attractive investment themes. There is no doubt that artificial intelligence will transform the economy as much as new technologies. However, investors must calmly separate hype from investment opportunities. The Internet dramatically changed the global economy, but if you had bought the Nasdaq a full year before the tech bubble peaked, it would have taken 11 years to break even. As AI investments are already on the exciting side of the see-saw, they may similarly disappoint investors.
Individual investors appear to have become risk takers as they ride the seesaw upwards. Look at their portfolio’s “beta” – a measure of how volatile their positions are relative to the market. A beta below 1 indicates a less volatile holding, while a beta above 1 indicates a more volatile holding.
According to the Bank of America strategy team, the typical equity beta in a private client portfolio in 2009 was about 0.75, with an equity allocation of 39%. Today, the beta is 1.20 and the allocation ratio is 60%. Total equity exposure (allocated time beta) indicates individual investor confidence and shows little sign of the fear they displayed in the early stages of a bull market.
Individual investors enthusiastically ride the seesaw upward, but the increased risk they take shows they forget that the seesaw has two ends. Better, broader investment opportunities may be on the side of the saw closer to the ground.
Svlook
