Market highs amid global uncertainty: a paradox of modern equity investing

This article was produced in partnership with Canada Life Investment Management Ltd.

The current market backdrop might suggest that bullish sentiment is on the rise, given the strong double-digit returns year-to-date in U.S. equities. Concerns are growing regarding the source of these returns, however, specifically the dominance of a small number of mega cap stocks. International and Canadian markets have also performed well in the first half of 2024, although this momentum slowed in the second quarter of 2024.

The North American economy is still dealing with inflation, as well as the intense scrutiny of the Federal Reserve’s next moves. Globally, there’s significant political change underway, with major elections happening throughout 2024, while conflict continues to rage in the Middle East and Ukraine. Despite these uncertainties, equities overall have generally performed robustly in 2024.

In conversation with Wealth Professional, Beutel, Goodman & Company’s Vice President, U.S. & International Equities, Colin Ramkissoon, discussed some of the factors behind the strong performance of equities in the first half of 2024.

Market concentration

Portfolio manager of Canada Life Canadian Focused Value Fund and Canada Life Canadian Value Balanced Fund, Ramkissoon highlights the unprecedented market concentration in a small number of well-known stocks, often referred to as the “Magnificent 7”. These stocks have driven a significant portion of the market’s returns. In fact, in the second quarter of 2024, the S&P 500 would have produced a negative return were it not for the Magnificent 7’s return of 17.1% (USD).*

Currently, the top 10 stocks in the S&P 500 by market cap make up about 35% of the index, a level of concentration even higher than during the 2000 tech boom. Ramkissoon says, “Historically, such trends do not sustain over long periods and tend to reverse, as seen in past market cycles. While these may be excellent companies, history suggests that this concentration is unlikely to continue indefinitely.”

As the Beutel Goodman portfolio manager explains, there will always be certain trends driving markets at a particular time. Currently, clean energy and technology are significant themes, and the AI theme has allowed companies like Nvidia to grow exponentially in recent years. Currently, a handful of companies (such as Nvidia) are trading at very high premiums. Some investors are willing to pay any price for exposure to these themes, but that’s not the approach at Beutel Goodman.

The valuation gap: growth versus value

Regarding significant trends, there's a valuation discrepancy between growth and value that persists. Ramkissoon points out that looking back over the last 20 years, the extent of that gap is in the 90th percentile, meaning only 10% of the time has it been more extreme than it is now. There's a strong argument that this gap will not persist indefinitely.

This phenomenon is happening in both U.S. and international markets. Interestingly, both growth and value are trading at historical extremes. If you look at broad growth indices like the Russell 1000 Growth for the US market, it is trading at a higher level relative to the general market index. Over the past 20 years, only 12% of the time has it been more extreme in terms of valuation discrepancy.

The value index relative to the core, represented by the Russell 1000 Index, is also trading at an extreme discount – it has only been cheaper 6% of the time over the same time period. So, growth is trading at an extreme premium, but value stocks are trading at an extreme discount to the core market.

“This tells us two things: growth is expensive, but value is very cheap. As value managers, this matters a lot to us. We don’t necessarily need both gaps to close, just one returning to its normalized state over time would work well for us,” says Ramkissoon.

Beutel Goodman’s investment philosophy centres on fundamental value investing with a strong quality bias. The firm’s high-conviction portfolios focus on buying companies at significant discounts to their estimated intrinsic values, driven by free cash flow.

“We stick to our investment philosophy and process, which have been time-tested and are agnostic to chasing the latest themes,” says Ramkissoon. “We are value investors with a very high-quality bias, and chasing trends doesn’t align well with that approach.”

“We see value in consumer staples and health care, particularly companies that are not participating in the rally but have strong fundamentals and growth potential,” he said.

Ramkissoon pointed out that select companies in these sectors provide opportunities due to their defensive characteristics, resilience in various economic conditions and attractive valuations. For instance, many high-quality health care companies with robust pipelines and strong operational foundations are currently undervalued compared to the broader market.

Long-term asset allocation and performance

A key aspect of Beutel Goodman’s approach is its adherence to a long-term investment focus, allowing the firm to navigate short-term volatility. The firm’s commitment to high-quality businesses with robust fundamentals helps them manage through various economic cycles.

In a typical balanced fund, you might have two or three equity sleeves and one fixed income sleeve. At Beutel Goodman, asset allocation is driven by the relative long-term attractiveness of each of those sleeves. The portfolio managers understand the potential upsides and downsides for each of our stocks, which gives them a risk-adjusted number for the portfolios. Ramkissoon assesses the potential returns and attractiveness of the individual sleeves and make asset allocation decisions based on that.

This approach has led the Beutel Goodman team to maintain a long-term overweight in equities due to their relative attractiveness compared to fixed income. This strategy has historically worked very well over the long term, as evidenced by the funds’ performance history.

Have a question about the investment manager and their mandates? Contact your Canada Life Wealth Wholesaling team.

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This interview is part of an ongoing series about Canada Life’s approach to investing with its partners around the world.

*Data from Eikon, London Stock Exchange Group plc.

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