Sporting triumphs hold a unique fascination, especially if achieved after many years of disappointment or overwhelming dominance. Nothing exemplifies this better that Bayer Leverkusen recently winning Germany’s Bundesliga title. After being known as the “Vizekusen” or perennial runner’s up for over 20 years, the club’s championship win last weekend was a surprising and outstanding achievement.
However, it’s not just the success of a small-town football club that has lifted spirits in recent months, but also the remarkable performance on the financial markets, which has helped to significantly increase the value of our portfolios. While this positive market development is less surprising than the title-winning feat from a historical perspective, it can’t be taken for granted given the challenging global economic climate and various geopolitical conflicts.
The substantial gains on the US stock markets have been remarkable. In particular, the shares of companies with strong earnings growth relative to the economy as a whole have climbed sharply in value. These growth stocks have risen by over 25 percent since the equity market rally began in November 2023. The best-known example is Nvidia, the US chip manufacturer, whose share price has soared by 115 percent over the same period. The dominance of growth stocks on the equity markets is similar to that of Bayer Leverkusen this season.
However, just like in sport, the question is how long a series of triumphs can be sustained on the financial markets. That’s why our reservations over growth stocks have grown in recent weeks and months. Firstly, the valuations of these shares have now reached very elevated levels. For many companies, high expectations of future earnings growth have already been priced in as shown by the frequently used price/earnings ratio (P/E ratio). The P/E ratio of the current high-flying stock Nvidia stands at over 70.
Secondly, our concerns over stubborn US inflation have been borne out. There’s a risk of core inflation becoming entrenched at just under 4 percent, which is twice the US Federal Reserve’s target. In this climate, substantial policy rate cuts look an increasingly distant prospect. The markets responded this year by raising long-term interest rates considerably. They may even go up again unless more progress is made on combating inflation. Above all, this will have an adverse impact on equities anticipating strong earnings growth as a rise in interest rates would lead to greater discounting of future profits.
To counteract the exhausted upside potential of growth stocks, we’re realizing the gains on US shares with a high proportion of these securities and reducing their allocation in the portfolio. Instead, we are building up our positions in global value stocks. They have a more defensive character, lower valuations and are less sensitive to high interest rates in the USA, which now look set to continue for a longer period, due to their relatively high profits already – and lower predicted earnings growth.
