Global Equity Investor insight | August 2023

Jeremy Richardson

Hello, this is Jeremy Richardson from the RBC Global Equity team here with another update. Just wanted to share with you some thoughts about what we're seeing in global equity markets at the moment. I think a lot of people have been somewhat surprised at the development of global equities. They've been fairly strong so far year to date. And I think this contrasts with a lot of caution that was being felt by investors at the beginning of the calendar year, really driven by concerns that there would be an economic recession of the first half of 2023.

Well, so far in 2023, that hasn't happened. And instead, we've had positive share price developments which has actually driven the market higher. And a lot of that has been led by a narrow group of companies who have got, you know, very much exposed towards artificial intelligence. And I think that's actually, on the one hand, a very positive thing because it's a really interesting new dynamic and a really interesting technology that can improve productivity more generally across the whole economy.

On the other hand, I think it's perhaps indicative of the fact that these kinds of stocks were perceived as being sort of a safe place to hide if you are concerned about an economic slowdown. That's actually presented quite an interesting position that we find ourselves in markets now as we’re coming into the current results season because we do see quite an extended market between, on the one hand, this narrow group of AI related names which have led the market higher so far, and what we might call the other stocks which have been somewhat left behind.

There are big valuation differences between these groups as well. If you just look at the S&P 500, for example, the market cap weighted index, so this is the normal index that gets the newspaper headlines, is knocking on the door around 20 times p e multiple, which, you know, a lot of people are looking at and sucking their teeth and thinking it is looking fairly valued.

However, if you look below the surface, perhaps using the S&P equity weighted index, so this is exactly the same companies, but each company is given the same weighting, you see that the p e multiple there is about three and a half points lower than the market cap weighted index. And that's much more consistent with what we've been seeing historically, so we're kind of back to pre-pandemic valuation levels.

So it's kind of an interesting setup. And what's been curious to see over the course of July is that although year to date a lot of the stock market development has been driven by this narrow group of AI related names, more recently in the last few weeks actually there's been much broader performance across the market. And that's, I think, a much more healthy development for global equity markets because it's no longer seeing the market being driven just by this narrow, narrow group of sort of very topical companies.

So, does this mean that the development of global equity markets may broaden out, that we may see some of these other companies sort of pick up the baton and deliver a strong performance for investors?

Well, to some extent, we come back to where we started in terms of the economic outlook. And it's very hard, I think, for investors to be able to predict with confidence whether or not we're going to get a recession or not. But I do note that a lot of economists are reducing the probabilities they’re attaching to a recession.

And the chances of a soft landing, at least according to consensus, are beginning to improve. Now, this is happening at the same time as interest rate expectations are beginning to peak. We're seeing a culmination in the interest rate increasing cycle. There is a debate about how many more interest rate increases the Fed and other central banks are going to put through. Whether there's going to be a pause, or there's going to be another 25 basis points or so, still actually captures some of the markets of focus and attention. But out in the real world, where interest rates are nearly 5% anyway, an additional 25 basis points is hardly going to make a huge amount of difference, its hard to think of a company which is going to be changing its investment decisions based upon an incremental 25 basis points or not. So, it feels as though the cake is mostly baked at this particular point. And who knows whether or not interest rates will sort of fall in the near future or whether or not they're going to stay higher for longer.

But fundamentally minded investors, a bit like ourselves, will greet the culmination of the interest rate cycle with some degree of relief, because as for investors generally, higher interest rates have been a valuation headwind, it feels like for at least the last 12 months or so. And to the extent that actually that, you know, uncertainty created by higher interest rates is now beginning to diminish, it should mean that attention will focus back onto company fundamentals, because when thinking about valuing companies, investors have just got those two things to worry about. Firstly, forecasting future profits and secondly discounting those back to today using the right discount rate. Now as uncertainty around that discount rate begins to diminish, we get more visibility about where interest rates are going to be. Then in theory, the only thing that's going to be driving share prices are going to be forecast of future profits.

And so that's where hopefully we begin to see this sort of broadening out of the market. These other companies also begin to participate, and also, I think, the returns for investors who are looking at company fundamentals should also begin to improve in that kind of a world because better businesses should be able to deliver superior company profits. And ultimately, we know in the long run, its those better profits that really drive long term share price valuation.

I hope this has been of interest and I look forward to catching up with you again soon.