The first calendar quarter was extraordinarily powerful for the price momentum factor – in layman’s terms, stocks which had gone up a lot in the previous three to six months tended to keep going up.
The MSCI World Momentum Index rose more than twice the broader MSCI World Index, increasing 21.2% versus the index up 9.9% in sterling terms. This degree of outperformance was the third-largest since the Momentum Index’s inception in the third quarter of 1973, surpassed only by the fourth quarters of 1984 and 1999, and was to the statistically minded a 2.8 standard deviation event.
We would not make too much of a 1999 comparison, as we are very aware that equity markets are what those statisticians would call a ‘non-stationary’ time series, in which the past doesn’t have the same deterministic effect that it does in stationary series (think coin flips).
The intuition behind this is that markets remember in a way that coins being tossed do not – the history of booms and busts has a ‘scarring’ effect on the collective minds of investors and means we cannot automatically extrapolate from what followed after Q4 1999 or, for that matter, Q4 1984.
Eyes on earnings
Evenlode’s valuation discipline and process mean that we rebalanced all our portfolios through the first quarter of 2024 into positions which were becoming better value as prices fell, in a market where this was an unusually punishing trade for relative returns.
Our focus is on a company’s cash earnings potential, adjusted for risk and capital intensity, over a horizon of five years and beyond, so there will be times when price momentum and long-term earnings potential diverge. When this happens, we will always follow long-term earnings potential.
There will also of course be times when price momentum and long-term earnings align. Our strategies are not necessarily negatively correlated with momentum, particularly when related to the wider index. However, history suggests that when momentum is unusually strong, our style is likely to suffer in relative terms. We think this is particularly the case right now when momentum is being fed by two separate waves, both of which tend to exclude the Evenlode Global Equity fund.
In the first group (as was the case in 1999 with the bull market in technology, media and telecoms) powerful thematic trends around generative artificial intelligence (AI) and drug innovation in GLP-1s for diabetes and obesity are driving some mega-caps to extraordinary new highs.
While we have exposure to the generative AI trend through Alphabet, Amazon and Microsoft, we have avoided pure plays on these trends as we are cautious around cyclicality and high thematic concentration.
Secondly, more like the Volcker boom of the 1980s, securities prices are being adjusted upwards after a period of inflation and a widely feared recession, in expectation of continued declines in borrowing costs and a resurgent global economy driven by the US. This has restrained the relative performance of companies which are less sensitive to changes in rates and economic growth.
With that being said, work we have done on fundamental earnings revisions suggests that our portfolio companies’ earnings expectations were little different to those of the index during the quarter.
Emerging opportunities
We prefer not to spend too much time worrying about factors and the macro context. The resilience of our portfolio companies’ earnings, both in the Q4 2023 reporting season and in the incremental revisions to consensus, makes us additionally confident that we have not strayed in our pursuit of compounding ability.
There are many things our companies are up to which excite us. For example, the opportunity for the card networks Mastercard and Visa to expand their sales of value-added services to issuers, acquirers and merchants; the opportunity for traditional data firms such as Verisk, Experian and RELX to improve the productivity of clients by offering more sophisticated analytics packages; and the opportunity for beauty and spirits companies like L’Oréal and Diageo to expand their footprint in emerging markets while further extending their innovation-based pricing pyramids in developed markets.
We expect there will be more ingots of treasure to heap onto the ‘weighing machine’ of cumulative shareholder earnings, described by Benjamin Graham. In the short-term, as Graham also observed, the market may vote to send momentum higher, but it is in these very times when you must stay the course.
James Knoedler is portfolio manager of the Evenlode Global Equity fund. The views expressed above should not be taken as investment advice.