Inside the mind of investors - March 2024
Big is beautiful. But will the pendulum swing?
We all know what investors are doing. But what are they thinking? Edison has plenty of insight and, towards the end of every month, takes you Inside the mind of investors.
Small and mid-cap stocks are cheap. Everyone sees it. Everyone says it. And yet few investors are buying them.
What’s running interference in the minds of investors, cutting off demand for smaller stocks, despite their undeniable value?
Firstly, the rapidly evolving theme of AI is taking precedence in the thoughts of many, if not most, investors.
Few doubt AI is a new general purpose technology, one which is already infiltrating our lives quicker than any other. And that, like most networked products, the market shape is likely to be an oligopoly – a very big market owned by a tiny number of very large winners. The latest publicly available valuation of OpenAI is $80bn, while the second largest pure play, Anthropic, is valued at a comparatively small $15bn, with third-placed Hugging Face worth just $4.5bn.
Perhaps even more strikingly, investors expect AI to further entrench the rest of the big-and-getting-bigger status quo.
In the land of Big Tech, Microsoft, Google and Amazon are harnessing the commercial potential of AI quicker than start-ups. OpenAI aside, which is very much Microsoft’s double-sided golden ticket, no newcomer can build reach quickly enough to compete.
Meanwhile, other large corporates appear to be adopting AI at speed as well. Investors believe the big guns have the will, the money and the people to make AI work for them, allowing the existing global giants to entrench their scale and profitability.
The Matthew effect is writ large – success is expected to generate more success. Polar Capital’s ￡9.6bn tech team, for instance, has slashed exposure to businesses not actively pursuing the AI theme.
Secondly, just as Labour’s Shadow Chancellor Rachel Reeves has identified ‘securonomics’ as a vote-winning, wealth-building zeitgeist, investors also have stability on their minds.
Large stocks are, of course, inherently more stable than smaller ones. The upheavals of the past 15 years – from the global financial crisis to the COVID-19 pandemic – have somewhat re-educated investor psychology, making resilience a more attractive quality than ever.
And big isn’t just beautiful. It’s nimble too. Such high levels of liquidity mean tails can be turned at the first sign of fresh trouble.
Then there’s the momentum we’ve seen since the start of the year. The Nasdaq 100 is up roughly 10% year to date. NVIDIA’s share price has, of course, almost doubled. Purchasers old and new continue to pile in, expecting more of the same.
Yet every trend is finite.
Perhaps current thinking will persist – as an underlying set of assumptions, rebalancing the historical price differential between micro- and mega-cap stocks. But unless we forecast that competition will die across the economy, the gap cannot continue to widen forever. Although, in typical stock market style, the trend will likely overshoot before it corrects.
Which means it is inevitable that, at some point relatively soon, a significant part of the market will start to worry that big no longer looks quite so beautiful. That, in fact, it looks somewhat overinflated. And that the relative discounts elsewhere are too generous to miss.
Look forward to September and the mindset of investors, from the largest to the smallest, might, in the UK at least, be somewhat transformed.
Inflation should be continuing to fall, interest rates should be deflating as well and various measures designed to boost demand for UK equities could be close to launch. The recommendations from the Investment Research Review – including a research platform for equities – could be the start of a share-owning renaissance.
We can also expect to have heard more detail from Rachel Reeves on how she would deliver securonomics: a vision in which ‘our businesses are world leaders, where Britain has a leading role in the industries that will define our future’.
The question for small and mid-cap stocks is: What are you doing now to take advantage of tomorrow when the pendulum swings? How will you stand out? Will the market know your equity story? Will your plans to deliver exceptional growth stand out?
Fortune often favours the brave – and sometimes the downright timely or simply belligerent.
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