In the year 2023 we would – with a probability bordering on certainty – be heading for a recession. Analysts, macroeconomists and other prophets all agreed. The inverted yield curve, the tightening policy of the central banks, high inflation, high interest rates and a disappointing restart of the Chinese economy. All ingredients that would bring a doomsday scenario closer.
The summer holidays are also over for the prophets and they will conclude that economic growth figures have not collapsed and stock markets have experienced a very strong first half of the year, partly driven by the Artificial Intelligence (“AI”) boom. Pessimism has therefore made way for optimism and expectations have been significantly adjusted upwards. For us, this is a reason to become more careful.
Profit figures:
In the past two months, companies have announced their half-year results. In 80% of cases, published profit figures in the US were better than expected. That is a very high percentage historically. When we dig a little deeper into the figures, two things stand out. Firstly, the extent to which actual profit figures exceeded expectations is very small compared to other quarters. Secondly, we see that only 63% of companies had revenues that exceeded expectations. That is significantly less than the average of 71% over the past four quarters.
The market further expects that American profits in Q3 and Q4 will increase by 1.3% and 9.7% respectively compared to the third and fourth quarters of 2022. After that, 2024 profits will (again, according to expectations) see another 12% increase. We believe that the risk that market expectations turn out to be too optimistic has increased.
Valuation:
Now that profit growth in the first half of the year has been higher and profit expectations have been adjusted upwards, you could feel more comfortable as an equity investor.
However, the some share prices have risen so sharply that we believe that increased profit expectations cannot fully explain this. We believe that the stock market as a whole has become more expensive because earnings growth is not keeping pace with the rise in equity prices.
Partly due to the craze surrounding AI, achieved returns by a broad stock index such as the S&P500 are concentrated around a select group of large American technology companies. The seven largest companies in the US (Apple, Microsoft, Nvidia, Google, Amazon, Facebook/Meta, and Tesla) make up approximately 84% of the return of the S&P500 index.
Due to their enormous size, this select group has become characteristic for the entire stock market. In our opinion, their stellar performances conceal some general stock market weaknesses, which actually reduces our comfort.
Secure profits:
The increased share prices in 2023 have made a significant contribution to the recovery of the value of our customer portfolios. As a result, the total weight in equity has increased and we believe it is wise to secure these price gains. With a number of sales transactions mid-September, we reduced the weight in equities back to the strategic weighting and we will wait patiently to see how the market will develop in the coming months. We rather secure some profits than rely too much on the wisdom of prophets. “Profits over prophets”.