What caught my eye this week.
Even the most strategically disinterested passive investor – that’s a compliment, incidentally – will know that the biggest US technology firms were what drove global equity returns higher last year.
I featured dozens of links in 2023 to articles charting the rise of the so-called ‘Magnificent Seven’.
Behemoths such as Microsoft, Amazon, Apple, and Alphabet that couldn’t possibly get any more highly-valued. Until they did!
Broaden the lens to the asset allocation level and things were almost as skewed. Not only did a handful of mega-cap equities drive returns – but equities, especially US ones, were really the only game in town.
And let’s not remind ourselves of the nightmare of 2022.
But okay, if we must then you’ll recall it was the year that diversification utterly failed and pretty much every asset went down. Starring, of course, the worst bond bear market in several generations.
Very high inflation and rising rates sent bond yields soaring and bond prices crashing.
This was not unpredictable given the pace of rate rises (which were unpredictable).
But it did make one despair of owning a diversified portfolio, and saw the 60/40 portfolio written off as dead (again).
Last year already proved that particular obituary to be premature (again, again). Especially in the US.
But while an end to the free fall in bond prices didn’t hurt, the truth is the 60/40’s decent showing was in no small part due to those biggest tech companies returning 50-100% or more in a single year.
So diversification worked, but only because it didn’t get in the way of what really worked.
Risky business
This all-conquering short-term dominance of equities is not an inevitable state of affairs, as this graphic from Legal and General’s 2024 outlook explains:
The graph shows that from around late 2001 to 2014, investors were rewarded – on a risk-adjusted basis – for having diversified portfolios, compared to if they’d only held global equities instead.
Since then though, more often than not owning anything but equities has been a drag.
This probably won’t last. Not least because high-quality government bonds now boast nominal yields of 4-5% or more thanks to the big sell-off, as opposed to the 1% or so they touted before it.
But also because sooner or later the global slowdown we’ve been promised for 18 months should finally arrive, even if it’s a mild one – and because central banks are due to start cutting rates regardless with inflation falling.
Given all the argy-bargy unfolding on the geopolitical scene, I’d certainly take a recession as the casus incisus that sends bond yields down and hence lifts bond prices – in preference to the potential casus belli rattling across the news.
Indeed Legal and General’s head of asset allocation says:
…this is, in our view, not an environment in which to bet on the concentration of risk. One might be lucky and avoid a crisis but if not, performance could be terrible.
Instead, we believe it’s a matter of spreading risk over multiple regions and multiple return drivers.
Over a longer horizon, we believe diversification should outperform more concentrated portfolios on a risk-adjusted basis.
The historical average of the difference in Sharpe ratios is in favour of diversification, according to our calculations.
First among equals
As I’ve written before, it’s conceivable we’ve entered a late-capitalism endgame where the half-dozen or so mega-companies that got to scale just as AI arrives have the data pools and moolah to win forever.
In which case prepare for either a terrifying dystopia or Ian M. Bank’s culture, to suit your taste.
It seems safer to bet though that the stock market is having one of its moments. That, magnificent though these market darlings indisputably are – perhaps the best businesses we’ve ever seen – they won’t prevail perpetually any more than Vodafone, Standard Oil, or the Dutch East India Company did before them.
In which case it’s probably best to keep a sense of balance. Not least in your portfolio.
More good reads from this week on the theme:
- What to expect when you’re expecting – Fortunes & Frictions
- Why naysayers were wrong about the 60/40 portfolio – Morningstar
- Should your portfolio be 100% in US stocks? – Of Dollars and Data
Have a great weekend!
From Monevator
Our 10-year asset class returns quilt for UK investors – Monevator
FIRE-side chat rekindled: a year in the country – Monevator
From the archive-ator: Become your money hero – Monevator
News
Note: Some links are Google search results – in PC/desktop view click through to read the article. Try privacy/incognito mode to avoid cookies. Consider subscribing to sites you visit a lot.
UK economy will be £311bn-a-year smaller due to Brexit by 2035, study finds… – Sky
…here’s the full report – Cambridge Econometrics
Blackrock warns of politics-inspired backlash in UK bond market – Proactive Investors
Craft beer giant Brewdog abandons real living wage for employees – BBC
UK residential property discounts narrow as sellers lower prices [Search result] – FT
Apple to release its possibly revolutionary Vision Pro headset on 2 February – Apple
There’s a huge and barely-reported Covid surge going on globally right now – Wired
Huge ancient city found in the Amazon – BBC
The FTSE’s biggest companies over time [Animated on FT, search result] – FT
Products and services
NS&I cuts Premium Bonds prize fund rate to 4.4% – Which
A bigger deposit doesn’t lower mortgage rates as much these days – This Is Money
Get between £100 and £1,500 cashback when you open an ISA with Interactive Investor before 31 Jan. New customers only. Minimum £2,000 deposit. Terms apply. Capital at risk – Interactive Investor
Barclays and Santander cut mortgage rates as competition intensifies – BBC
How does TSB’s new rewards portal compare with getting cashback? – Which
Aldermore’s new regular savings account pays 5.25% – This Is Money
Open an account with low-cost platform InvestEngine via our link and get up to £50 when you invest at least £100 (T&Cs apply. Capital at risk) – InvestEngine
Streaming price hikes: how Netflix, Prime, and others have all gone up – This Is Money
Dating apps test just how much users will pay for love [Search result] – FT
British Gas earns rave reviews for revamped five-star service – This Is Money
Homes for sale near swimming pools, in pictures – Guardian
Comment and opinion
Are you in control of your investment decisions? – Index Fund Advisors
Myth-busting the new side-hustle tax rules – Be Clever With Your Cash
Wear the same thing most days – Slate
Do stocks really make sense for the long run? – Morningstar
Larry Swedroe: 12 lessons the market taught investors in 2023 – Morningstar
Winning the game: retiring at 57 with $4.2m – Best Interest
You don’t need everything you want – Vox
Quitting the corporate life to become a crossing guard [US but relevant] – Slate
Five things you need to know before you retire – Retirement Manifesto
The annuity puzzle revisited – Center for Retirement Research
Final chapter – Humble Dollar
The easily-amused mind is simply happy – Mr Stingy
New Year, new ramble by @ermine – Simple Living in Somerset
[US] spot Bitcoin ETFs approved mini-special
Most UK investors can’t buy these US ETFs. Links for big picture/posterity.
The ins-and-outs of the spot Bitcoin ETFs – Morningstar
Dave Nadig: why a Bitcoin ETF doesn’t matter – ETF Trends
Vanguard says it won’t offer spot Bitcoin ETFs on its [US] brokerage – The Block
Bitcoin falls on ETF launch, while ether heads for an 18% gain on week – CNBC
Naughty corner: Active antics
Reviewing a 12-year-old UK dividend stocks portfolio – UK Dividend Investor
The periodic table of commodity returns [Infographic] – Visual Capitalist
Uranium prices just hit highest level since 2007 – Semafor
The ‘riptide’ economy explained – Axios
Kindle book bargains
What They Don’t Teach You About Money by Claer Barrett – £1.99 on Kindle
Kleptopia: How Dirty Money is Conquering the World by Tom Burgis – £0.99 on Kindle
Fooled by Randomness by Nassim Taleb – £1.99 on Kindle
Make Your Bed by William McRaven – £0.99 on Kindle
Environmental factors
2023 saw the hottest global temperatures on record – Copernicus
The UK farmers holding off flooding the natural way – Guardian
Humpbacks rebound in 20th-Century whaling hotspot – Hakai
World’s renewable energy capacity grew at record pace in 2023 – Guardian
The backlash against ESG seems to have gone nowhere – Klement on Investing
Building a sustainable planet – Faster, Please! [hat-tip Abnormal Returns]
Kew Gardens names mysterious plants and fungi new to science – BBC
Off our beat
“We need jungle”: how University Challenge spawned a remix craze – BBC
How the Internet was reshaped around Google [A must-read if you don’t know, and why Monevator is trying to move to a membership model] – The Verge
Nice view. Shame about all the tourists – Noema
The nature of evil – We Are Gonna Get Those Bastards
What democracy loses when we lose trust – The Atlantic via MSN
Understanding human stupidity in the post-truth era – Klement on Investing
How to read more books than ever in 2024 – Inside Hook
Evolution is not as random as previously thought – Phys.org
Avoiding technology – Seth Godin
Years don’t make you old – A Teachable Moment
And finally…
“The ease of online dealing makes many people act as if investing was positively scored, but the arithmetic of compounding dictates that it is really negatively scored. Success in investing consists mainly of avoiding big mistakes.”
– Guy Thomas, Free Capital
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> investors were rewarded – on a risk-adjusted basis – for having diversified portfolios, compared to if they’d only held global equities instead.
I had to pinch myself as a 100% equity guy thinking while reading this that surely global equities is already fully diversified, but of course what you mean is asset class diversified, and that the time for the classic Bernstein 60/40 stocks/bonds. Whose day may or may not come. Thanks for the link and here’s to a good 2024, and the Culture book series looks interesting!
@Ermine – start with “Player of Games”.
I think it is a truism that only a very few companies out of the many that compose the stockmarket actually drive the beast upwards at any one time
I feel sure there are papers/studies on this though I cannot quote them
It would seem to be normal stockmarket behaviour
For the lucky souls that pick a winner delight awaits -for the rest of us amateur investors running a total stockmarket index fund is the only answer
You won’t get as gob smackingly rich as the lucky few but you stand a good chance of achieving your financial goals which is all that counts
xxd09
Interesting story I read recently (courtesy of Edward F. McQuarrie) goes as follows:
At the peak before the 1837 Panic hit, the 2nd Bank of the United States accounted for almost 30% of total market capitalization. It failed spectacularly as the Panic proceeded, with shares dropping in price from $120 to $1.50, and never recovered.
To apparently duplicate this omission in the contemporary stock market, it would be necessary to drop Microsoft, Apple, Amazon, Alphabet/Google, and Facebook from the S&P 500; and even these five would not account for as high a percentage of S&P 500 capitalization as did the 2nd BUS at its peak.
If you look at returns over the last decade for conventional assets (equities, bonds, property, cash) then only one thing is actually delivering over 10%/annum: US equities (and US tech specifically). Without that, it’s a fairly mediocre set of returns from 0-6% or so.
Even inside US equities, the return concentration is massive. I haven’t looked at it since Nov but at that point the S&P was up around 9% on the year. The equally weighted S&P, however, was down 4%.
Now, it’s normal behaviour in the S&P for <20% of the stocks to deliver over 80% of the returns. Over 50% of single stocks underperform cash. It's all about a few multi-baggers. The primary reason to hold an index tracker is simply not to miss those few. Moreover, it’s the nature of market-cap index-tracking to be a momentum/trend follower.
The issue now though is how extreme that behaviour has become. I run a principal components analysis on the return-volatility behaviour of the conventional assets in my portfolio, and the concentration to two orthogonal components is at a multi-decade high. Equity returns are dominated by a handful of tech stocks. I can replicate over 90% of the behaviour of my portfolio with a handful of equities and an FX overlay. I don't need a bond in there since those tech stocks act like bonds. Despite all the headlines about AI, those tech stocks seem to act remarkably like a levered long duration US treasury. It's just a very low dimension portfolio.
If the performance of the magnificent 7 is finally turning, it began in 2022. The layoffs in the US tech sector a year ago made headlines, and the story then was a “correction” for covid over-hiring, but since then hiring at big firms has all but ceased, with thousands more laid off just last week. At least in terms of labor, the tech industry remains in a deep recession, worse than anything in the last 20+ years (or ever).
Anecdata: In mid-2020, with companies grasping for covid loans or going under, I was laid off but secured a new job within a few weeks. In 2024 I have been seeking a new job for over a year now, with just 1 screening call and 0 interviews for over 70 applications in 12 months.
Maybe cutting costs and constraining cost growth means a stronger business and future new highs for investors, but it sure doesn’t look like a healthy industry from the inside.
No offence meant and apologies if any is caused but Monevatorites, who might be alarmed by the Cambridge Econometrics report in the “News” section above, can take comfort from the sombre but objective data showing that the Brits are better able to handle the vicissitudes of life than their various near neighbours “across the ditch”, la dolce vita apart, and better than those “across the pond” and those in the English speaking Antipodes. https://en.wikipedia.org/wiki/List_of_countries_by_suicide_rate
I’m starting to feel optimistic about inflation – I couldn’t find the odds for negative inflation in 2024, any ideas where such things exist (Google was surprisingly unhelpful)?
My spread betting and CFD accounts were closed just in case I liked it too much!
@ZX – I’m a fan of concentration on US tech (for now), but also run with a variable level of stable asset as a downside protection, effectively shortening duration. The question is whether this is better than just running 100% of a less leveraged index, but at least there’s some control of things and option to rebalance.
I loved Swedroe’s 12 lessons. Number 2 being pertinent to your opening piece:
Lesson 2: Perhaps the Magnificent Seven Should Be Called the Magnificent Three
Three of the “Magnificent Seven” companies (Tesla TSLA, Alphabet GOOGL, and Amazon.com AMZN) ended 2023 below their closing price at the end of 2021. Only three (Apple AAPL, Microsoft MSFT, and Nvidia NVDA) outperformed riskless one-month Treasury bills, which returned 3.2% per year over the period.
Regarding the comments about diversification : In his 2009 article “Bonds : Why bother ?”, Rob Arnott made the fascinating observation that long-dated (20Y) Treasuries have outperformed US stocks for three separate stretches of 40 years or more (the last was 1968 to 2009). If you were unlucky enough to be investing during one of these 40+ year windows, your best bet was to hold 20 Year treasuries. Who knows if we’re about to live through another similar period ? As someone once said, nobody’s give away guarantees of free money – it’s called the equity risk premium for a reason ! https://www.etf.com/docs/magazine/2/2009_149.pdf
@Factor
A few other points on the Cambridge Econometrics report, just in the interest of balance, for those worrying unduly about it:
1. As others have pointed out online, the conclusions are based on a “modeled” UK which voted remain in 2016 – and ignores the impact of various real world events since then like Covid, Russian incursions into Ukraine, etc. So as with all “modeled” findings, take with a pinch of salt.
2. No offence to the staff at Cambridge Econometrics, but looking at their bios, unless they all have a really good moisturising regime, I’m struggling to see (m)any who are over the age of say 40 – meaning their entire economic outlook is based on an (artificially) low interest rate environment since 2008 which is being projected forwards.
3. As you’ll see on the report itself, it’s actually the second one which has essentially been commissioned by the London Mayor, Sadiq Khan. Not exactly an unbiased chap on Brexit. Those previously involved in this include Prof Richard Murphy, linked of course to Jeremy Corbyn as an economic adviser. The Prof is hardly “independent” on the matter of Brexit, as can been seen by his prediction of an immediate recession if the UK voted leave – see here: https://www.taxresearch.org.uk/Blog/2016/06/19/what-will-happen-to-the-politics-of-the-uk-post-brexit/
4. Even according to PwC, it’s not all doom and gloom in Brexit Land: https://www.msn.com/en-gb/money/other/global-bosses-back-britain-as-survey-shows-it-remains-strategically-important-for-us-and-chinese-firms/ar-AA1n3Bnt
🙂
does anyone know where you can get inflation index values, ideally through a nice web front end? Say CPIH, CPI and RPI values at particular points in time. Trying to do some real return calculations over at the rhino enclosure.
I note you can download csvs and stuff like that from ons.gov.uk but was wondering if someone had hooked that up to a UI, bit like the bank of england inflation calculator tool.
@Rhino (#13):
See:
https://www.ons.gov.uk/economy/inflationandpriceindices
@Dragon #12
And as the oft-quoted aphorism says, “All models are wrong but some are useful”!
As Naeclue #10 notes, in some ways the Mag 7 is really the Mag 3 – AAP, MFST and NVDA. Nvidia crushing it again today. $1,149 per share hit intraday (pre the 10 to 1 share split scheduled soon). Cap over $2.8 tn and may be heading to $3 tn soon if things continue in the direction and with the speed which they have been since the recent quarterly earnings came out.
At that level it’ll be on a chunky 70x trailing PE; but that metric is arguably pretty meaningless now with 600% + growth in earnings and 270% in revenue from last year.
I can’t recall anything remotely like it in year on year fundamentals’ performance for a stock already of the size and market share which it reached by 2022/23.
Although Nvidia can definitely go higher, maybe a lot higher eventually (depending both upon exactly how AI adoption and development plus crypto PoW mining demand pans out, and also upon how Nvidia’s wide moat fares in terms of maintenance of its cutting edge in high performance chips); it’s definitely also worth keeping in mind the bear case.
I’m not a Nvidia bear BTW, just saying to consider all sides of the argument.
So four words of warning: Radio Corporation of America.
In 1929 one of the stocks that especially ruined investors was RCA, the ‘Magnificent 1’ of the 1920s. RCA stock rose from $5.825 in 1921 to $420 in 1928 ($7,701.18 today), split 5 for 1 in March 1929, and peaked at $114.75 in September 1929, and then fell to just $2.625 in May 1932.
With reinvested dividends, split adjusted, RCA stock rose in price 200-fold before a near 98% decline.
It happened before, it could happen again.
Mark Stevenson yesterday: “NVIDIA is also the largest contributor to earnings growth for the entire S&P 500 in the last quarter. If this company were excluded, the blended earnings growth rate for the index would fall to 3.3% from 5.9%….NVDA alone is responsible for just under half of that 6% earnings growth seen this quarter for US equities.”