United States: The Inevitable Stock Market
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Niccolò Machiavelli reflects in his book The Prince on whether it is better in life to be feared or loved. According to him: “One would like to be both, but since that is difficult to combine, I assert that it is safer to be feared than loved.” This principle seems applicable to the spectacular rise of stock markets in 2024, where the stellar returns of a small group of large U.S. tech companies have dominated the spotlight of stock indices.
Driven by the artificial intelligence narrative, these companies have seen a notable surge in their stock prices, reaching historically high valuation levels that were almost unimaginable. Their current prices are so high they command respect. However, the weight of the U.S. stock market within the global index (67% of the MSCI ACWI) makes the cost of ignoring it enormous for any asset manager. At first glance, the abundant inflows into the U.S. market might suggest that investors are in love with big tech companies. But what if it’s the opposite? What if it’s all based on fear? The U.S. stock market is, in many ways, unavoidable: its weight is so overwhelming that the price of not being exposed to it is, quite simply, too high.
Main Market Returns: 30/09/24 - 31/12/24
To understand what happened in 2024, it is necessary to break down the returns of global stock markets. Half of the S&P 500’s return comes from the expansion of the P/E multiple, that is, the increase in valuation and expectations per unit of earnings. A similar phenomenon can be observed in the MSCI ACWI global equity index, where the U.S. market holds a dominant two-thirds weight.
However, the situation is radically different in other markets: here, there has been virtually no expansion of the P/E ratio, and returns have been driven exclusively by dividends and earnings generated by companies. In 2024, the privilege of higher valuations has been confined solely to the United States, leaving other markets in the background.
Index 2024: Breakdown of Contribution to Return
An investor in euros in the MSCI AC World achieved a return of 25.3%, but it is worth noting that 7.8% of this return is explained by the appreciation of the dollar against the euro. This movement has been driven by the weakness of the European economy and the divergence between the monetary policies of the Federal Reserve and the European Central Bank.
Dollar 2024: Contribution to Return of MSCI AC World 2024
For European investors, lacking exposure to the dollar has resulted in a drag on their performance. The message is clear: “an investor CANNOT afford” not to be exposed to the U.S. stock market, which is reflected in the forecasts of major investment houses for 2025 (most recommend buying U.S. equities).
Another recurring theme in the various forecast letters for the coming year (currently the Outlook’25) is the expectation of increased volatility. After all, there are always clouds on the horizon, and it doesn’t seem far-fetched to expect rain.
This year, the most frequently cited arguments revolve around demanding valuation levels, high fiscal deficits, and the imposition of tariffs by the Trump administration. All of these seem like valid points, but as we’ll see, that’s not the issue.
First, we need to explain what volatility is. A simple analogy could be a roller coaster: volatility measures how quickly the prices of financial assets rise and fall. Typically, more stable and predictable assets have low volatility, while assets with greater uncertainty exhibit higher volatility. For instance, in the chart below, we can see a comparison between the volatility of a stable company like Nestlé and a cyclical company like Acerinox.
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Evolution of Annualized Volatility 2011-2024
Volatility is also associated with periods of market panic, as we can see in the chart below of the VIX index (note the spikes in 2008 and 2020).
Evolution of the VIX Index 2000-2024
Therefore, volatility is associated with risk, and the two concepts are often confused. However, no, volatility is not risk, nor is it even a measure of risk. It is a measure of the perception of risk. This distinction is important and was at the heart of some of the most costly mistakes of the 2008 financial crisis.
In any case, when we see this type of forecast, two aspects catch our attention:
1)????? The willingness to engage in “market timing.”
Few investors have demonstrated the ability to make accurate predictions, a topic we have already addressed in the past. Here, we do not believe we are facing an exception, and predicting sudden changes in volatility seems to us to be a futile exercise. Especially when, most of the time, volatility remains at moderate levels.
Time Proportion by Volatility Regime
2) The contrast with their own positioning.
Few participants adjust their portfolio strategy to reflect their own forecasts. Despite expecting increased volatility, they do not have a portfolio that significantly differs from market standards, and we saw recently (2022) how this can take its toll.
At Alkimia Capital, we have always opted for a different, agnostic, and robust model. We do not know when the next crisis that will bring volatility will occur, nor do we aim to make better predictions than our competitors, but we design portfolios to withstand whatever storm may come.
It is essential to be prepared in advance because taking out the umbrella once it’s already raining is very costly in financial markets. Insurance must be in place beforehand, even if it seems like an unnecessary exercise most of the time.
“Prediction is very difficult, especially if it’s about the future.” - Niels Bohr.
All of the above does not mean that we lack a view on the economic and market reality around us. In fact, we believe that many dynamics often help us anticipate the magnitude and intensity of adjustments when they occur.
A current example is the high public deficit in the United States. It seems quite evident that this is not a sustainable policy over time, but predicting where and when the limit will be reached seems an impossible task. At the same time, it is easy to perceive the increased fragility this brings to the economy and that, when the next crisis comes, we will not have saved enough to face it.
U.S. Deficit 1930-2024
Our positioning remains largely unchanged. The strong performance and the increasing valuation of the U.S. stock market enhance the relative attractiveness of other regions, such as Europe or emerging markets, while overlooked sectors might deliver positive surprises in the coming years (energy?).
In fixed income, risks appear more balanced. While there is an inflation risk that cannot be ignored, we believe the gradual decline in fiscal stimulus will result in a less dynamic economy, where monetary policy may regain some of the prominence it has recently lost.
Finally, everything else. Our portfolios are filled with positions that protect us from certain scenarios that have yet to materialize. For some time, gold played this role in the portfolio, prompting frequent questions about its relevance. Ultimately, in 2024, due to a confluence of various factors, we saw how it protected us from geopolitical instability and government policies. We do not know when some of the elements under scrutiny today will bear fruit, but we are confident in their role within the portfolio: being prepared for the future, whatever it may hold.