This article was taken from the
November 2024 issue of Market Insight. To subscribe to our investment publications, please visit
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Elections are interesting distractions for financial markets, with commentators distributing vast volumes of comment pieces around the potential market reactions to anticipated policies. Most are derivative of the others, commenting on common themes of tax cuts, tariffs, and deregulation. Some however are comfortable with making more outright predictions as to the potential returns on offer for investors in the US markets.
The most interesting prediction piece of late comes from Goldman Sachs. In October, the firm released a global strategy paper, updating long-term forecasts for US equities. The piece made the key prediction of an expected annualised total return over the next 10-years of 3%, with a potential range of outcomes between -1% and 7%. That’s a 10-year predicted return range for US equities of between -9.6% and 96.7%. Market concentration in the US has been a consistent point of comment of late with the ten largest companies accounting for 36% of the S&P 500 index. The high level of concentration puts downward pressure on forecasts such as the one above, as it is hard for companies to maintain high levels of sales growth and profit margins over the long-term. In addition, concentration leads to a higher level of risk because the valuation of a few companies will have an outsized impact on the index. When the researchers removed the impact of market concentration in the statistical model, the predicted baseline annualised return forecast increased from 3% to 7%.
Much is made of the issue of concentration, but it’s nothing new for financial markets. In the UK, the top ten companies within the FTSE 100 index account for almost 46% of the index, and in the more nuanced market of Taiwan, the top ten index constituents account for 45.8% with the largest company holding a 22.22% weighting. There is an understandable concern for those looking to allocate capital into the US equity market with many turning to equally weighted Exchange Traded Funds (ETF) to mitigate the concentration risk, where the index weightings are equally divided between all constituents. In their 2024 third quarter European ETF Asset Flows Update, fund data platform Morningstar indicated a further €14bn flowed into US Large Cap Blend Equity ETFs, with three of the top ten selling products offering an equal weighted methodology.
Perhaps investors are learning from lessons past. According to Microsoft’s Copilot Artificial Intelligence tool, in 1999 the three largest constituents of the FTSE 100 index were Vodafone, British Telecom, and Royal Dutch Shell with approximate weightings of 8.5%, 7.0%, and 6.5% respectively. Declining fortunes of companies holding a large weighting in the index can have significant implications for the index’s overall return. From the end of 1999 to the close of October 2024, the FTSE 100 gained just 17% in price terms (not accounting for dividends) while Vodafone and British Telecom produced price returns of -77% and -87%. This example appears to support the argument of the Goldman Sachs strategists.
We make no predictions that the companies at the top of the S&P 500 index will falter and lead to meagre returns going forward. All are generally considered high quality companies, but the level of growth associated is clearly starting to be questioned. Within the recent interim report for Scottish Mortgage Investment Trust, portfolio managers highlighted a reduction in their Nvidia position, citing concerns over the sustainability of current capital equipment spending. On the other hand, they increased the portfolio’s position in Meta, citing positive effects of artificial intelligence on the company’s product offering. The Baillie Gifford team behind Scottish Mortgage are not alone, with the likes of GQG Partners, the US$155bn asset manager, also cutting its position on risk management grounds despite still being positive on the company.
The hope of many asset allocators appears to be for a broadening of returns within the US markets having experienced a highly concentrated growth rally. Post election, both the market capitalisation weighted S&P 500 and the S&P 500 Equal Weighted Index are higher, with the former marginally ahead of the latter. The market has reacted positively to the election outcome and President-elect Trump’s pro-business stance and desire for lower rates of taxation. An “America First” standpoint and the notion of increased tariffs on trade could bring about shorter-term volatility, but it’s important to remember that over the long-term, earnings remain the key driver of share price returns, not the political party in power.
Please note that this communication is for information only and does not constitute a recommendation to buy or sell the shares of the investments mentioned. Investments and income arising from them can fall as well as rise in value. Past performance and forecasts are not reliable indicators of future results and performance. The information and views were correct at time of writing but may have changed at point of reading.