Is it the end of easy gains for mega-caps?

Investors should resist the temptation to chase fashionable themes and instead focus on companies with lasting cash flows and sustainable long-term growth.

That was the overarching message from Ninety One’s investment outlook webinar last week, with head of quality Clyde Rossouw arguing that global equity markets, particularly in the US, have become narrowly concentrated and richly valued.

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After years of exceptional gains driven by a handful of mega-cap technology companies, investors are now in a more vulnerable position, he says.

Rossouw stresses that global markets are entering a period where disciplined stock selection is likely to matter far more than simply owning an index.

AI valuations raising concerns

Artificial intelligence (AI) remains one of the biggest investment themes, but asset managers are increasingly distinguishing between AI’s transformative potential and the valuations attached to the companies driving today’s rally.

Ninety One is not sceptical about AI itself, according to Rossouw.

“We are not luddites that are sitting there thinking that the world is not changing in front of us. We recognise those changes.

“What we are challenging, though, is this idea about how you can actually make money and which businesses will continue to grow their profit streams over time.”

Ninety One believes substantial capital spending on AI infrastructure has opened a widening gap between investment, cash flows and earnings, with investors increasingly assuming that spending alone guarantees future competitive advantage.

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It also warns that the growing number of cheaper AI models could make it harder to justify today’s high valuations.

Old Mutual Investment Group (OMIG) agrees that the current infrastructure boom is unlikely to produce the strongest long-term returns.

It says current valuations increasingly reflect lofty earnings expectations, with the “bubble” more likely to lie in future profit assumptions than in the technology itself.

The importance of stock-picking

Rossouw says Ninety One prefers companies with deep customer relationships, recurring revenues and “mission-critical products”.

He adds that investors have already begun moving away from semiconductors towards software companies that can produce compounding earnings over many years.

“We started to see the first signs of a change in sentiment. For the first six months of this year, people wanted to sell software and buy semiconductors.

“Then it was like the clock had turned over on the first of July, and now people are doing the opposite.”

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Ninety One is investing less in the market’s most expensive technology shares and believes investors should not rely too heavily on index-tracking funds if a broader range of companies starts driving market returns instead of today’s technology giants.

South African markets

Rossouw believes South African assets have, over the past two years, benefitted from:

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International investors reducing exposure to the US dollar;
Strong precious metal prices;
A resilient rand; and
Lower inflation.

However, those powerful tailwinds are beginning to moderate, with local equities becoming more volatile while cash and fixed-income investments have become increasingly competitive.

OMIG argues that South African equity valuations remain attractive relative to global markets despite the late stage of the global cycle.

Inflation and interest rates tied to oil

Jeremy Gardiner, director at Ninety One, said in his presentation that the global economy has proved more resilient than many expected despite conflict in the Middle East, higher oil prices and persistent geopolitical uncertainty.

Oil remains the biggest factor because it continues to drive inflation, interest rates and global growth, although he believes the likelihood of a prolonged economic shock has waned.

Citadel chief economist Maarten Ackerman argues that while worst-case fears following renewed US-Iran tensions have not materialised, the world is facing a prolonged disruption rather than a short-lived shock.

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Inflation remains the principal risk as supply chain constraints, freight costs and rebuilding energy infrastructure continue to filter through into prices.

“Even if oil prices ease, the effects will continue to filter through inflation, trade and economic growth,” says Ackerman.

Gardiner contends that even though South Africa is facing “challenging headwinds” it is coping relatively well and is “surviving the crisis better than expected”.

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