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Equity Focus - February 2024

From “Magnificent 7” to the “Super Six”?


From the “Magnificient 7“ to the “Super Six“


Key Points

Is this the beginning of the end? We talked a lot about the embedded risk coming from (too?) ambitious valuations from certain US Mega Cap stocks. The first victim of those expectations seems to be Tesla. As growth has slowed, so has investor enthusiasm which has led to a de-rating of its stock price and substantial underperformance vs the market and its “Magnificent 7” peers. In fact, we would argue that there are no “Mag 7” anymore but that we are now left with the “Super 6”.

Next, the “Fantastic Five”? If we are to see the rotation in stock leadership in the US stock market that we are predicting, a gradual drop-off of the Magnificent 7 one by one for different, stock-specific reasons over time would follow the typical pattern for such a rotation in leadership.

Fresh All-Time-Highs (ATHs) are encouraging. While many Investors are somewhat reluctant to buy when new ATHs are hit, being shy at that very moment may be the worst thing to do. ATHs are usually a sign of strength and followed by new highs. If it takes the S&P 500 12 months or more to hit a new ATH, the average performance during the following year was +14,8%, with a 100% hit ratio. 


Main recommendations

Upgraded US Small Caps to positive. We see the stars aligned for a period of outperformance of US small caps as valuations, historical market patterns and economic growth are indicated future relative and absolute strength. We prefer the S&P 600 over the Russel 2000.

We stick to our positive view on EU Tech despite the good run recently and continue to like a barbell approach of selected growth and value (e.g. financials) sectors.

Country-wise, we maintain our positive stance on the eurozone, UK, Japan and Latin America

Be cautious/selective with expensive market segments, such as some large-cap US tech stocks and some Consumer Staples.

We downgrade Chemicals to negative due to ongoing earnings risk and too high valuations

The key risks are that the US Federal Reserve or the ECB could raise interest rates more than expected, triggering a sharper economic slowdown or even a recession. Liquidity is likely to fall in the coming months, especially in the US.


Upgrading US Mid/Small Caps

Prefer S&P to Russell: not all Indices are created equal

The US economy is increasingly likely to manage a soft landing as a surprisingly strong labour market is supporting consumption. Small Cap equities are usually tied more closely to domestic economic activity as they cater more to domestic customers. It should thus come as no surprise that the Russel 2000 has the highest sensitivity to economic growth among major US equity benchmarks. This seems to be completely ignored by the market until now. Looking at the relative performance of US Small vs Large Caps, we find a level that historically only occurred during deep recessions, i.e., an ISM US Manufacturing PMI of below 30 – a level only reached once since 1950.

Relative performance obviously also influenced valuations which also reached extremes. The AI frenzy has pushed the valuations of the S&P Mid 400 and S&P Small 600 indices close to 20-year lows on traditional measurers such as P/E or Price / Book Ratios. This again seems to completely ignore the constructive economic environment. Beyond, we would argue that smaller companies (i.e. the users of A.I.) should at one point start to harvest the benefits of increased efficiencies.

Another interesting technicality is supporting our view of outperformance for US Mid/Small Caps ahead. While the S&P 500 recently marked a new all-time-high (ATH), US Small Caps where still more than 20% below their last ATH. Such a spread is highly unusual and happened only three times so far. In all cases, both indices rose during the next year, but Small Caps reached an average outperformance over large caps of ~ 15.5pp.

While the Russell 2000 is admittingly by far the most prominent product when talking about US Small Caps, Investors should be aware of the caveats coming from its construction: 41% of its constituents are unprofitable. In addition, since it includes many very small companies, only 5 sell-side analysts cover the median Russell 2000 stock while 13% of its members have no or just one analyst coverage.

The S&P 600 Small cap index on the other hand has a ratio of 88% profitable constituents and also a higher coverage among analysts. Since the volatility of the Russell 2000 is also higher, we prefer the S&P600 for engagements in US Small caps. The Russell should be only selected by very risk affirmative investors


ABC – All But China (?)


In the last couple of days there have been several rumours of market support as well as announced measures:

1.PBOC finally surprised to the upside with a bigger than expected RRR cut and announced other lending measures

2.China’s gaming regulator has removed from its website the controversial draft rules that crushed the sector several weeks ago

3.Joe Tsai/Jack Ma buying Alibaba stock. Remember you buy for only reason; one sells stock for many reasons.

4.Press reports that Chinese policymakers are seeking to mobilize about $278 billion, as part of a stabilization fund to buy shares

5.China’s Premier Li Qiang asked authorities to take more “forceful” measures to stabilize his country’s slumping stock market and investor confidence


While none of those measures is adressing the underlying causes of the economic slump in China, they may be enough to spark a (bear market) rally. For fresh money, we would prefer to trade such a rally via structured products while we would not add to existing positions which we´re looking to trim into any material strength.


Asian Equities view

Chinese RRR Cut rally fizzles but bottoming on-going

The PBOC surprised to the upside by cutting the reserve rate requirement (RRR) by 50 bps (effective 5 February 2024). This was preannounced in a press conference, suggesting urgency in addressing the structural slowdown China is facing. Recent quiet removal of the Online Game Management Regulations draft also suggests that authorities may refrain from adopting restrictive measures in the near term.

Chinese stocks saw the brief rally fizzle out as investors took opportunity to exit positions following news of liquidation on Evergrande from the HK courts. Sentiment remains weak, many investors remains under positioned while valuation stays attractive at levels last seen during the 2015-2016 China bear market. The put-call ratio has also trended down over the last two years, suggesting a bottoming process is in the making. We remain positive on China in the longer term though timing the bottom remains elusive.

Elsewhere, the Korea government has focused on bringing positive reforms on capital markets to address the so-called Korea discount (essentially low valuation vs regional peers like Japan). Some initiatives have been taken since 2H22 including to improve corporate governance, treatment of minority shareholders and boost shareholder return with many details still pending.  


Chemicals – Downgrade to negative

Being worse doesn´t prevent that it gets worse

2023 was a very bad year for chemicals and 2024 seems to become no better as this crisis is worse than 2008/09 or 2020. While Investors may be forgiven to think “that it can´t get worse”, we fear it can as the sector faces a perfect storm: Utilisation rates are likely to remain low as supply is expected to further outgrowth demand while the structural concerns on competitiveness for Europe (i.e. energy costs) will persist. On the other hand, we have a lack of permanent shutdowns globally, and a likely muted outlook for global GDP including a new lower norm in China. We thus expect further downgrades and reduce the sector to underperform. Within the sector, industrial gases should be the best sub-segment.


Lithium - stay on the sidelines

The recent collapse in Lithium prices is a function of rising supply (we see no sign yet that mines are cutting back production) and falling demand, especially from the EV-battery space. The EV market is now mainly dependent on the consumers willingness to switch from ICE to an EV as susidies are cut back in certain countries. There are growing conerns that this adoption will happen in a meaningful way, espcially in Europe. Challenging economic conditions and a lower price competitiveness of EV vs ICEs due to less subsidies and changes in energy cost may continue to dampen adoption rates. We thus see downside risks to EV growth expectations and a potential shift to hybrid models with smaller batteries. Given this bleak outlook, we prefer to stay on the sidelines until demand improves.