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Markets shifting to be less driven by top-down views: SSGA

By Rhea Nath
4 minute read

While valuations remain elevated in most parts of the market, State Street Global Advisors is forecasting company fundamentals to come to the fore as markets evolve to be more supportive of stock picking.

State Street Global Advisors’ latest equity market insights indicate investors may be pushed back towards fundamentals and away from higher-level macro and thematic positioning over the course of the year.

Highlighting a “ripping” first quarter, SSGA noted that developed markets posted a nearly 10 per cent return in the first three months of the year. Meanwhile, emerging markets, although dragged down by weakness in China, returned around 4 per cent.

More specifically, equity returns in the US stood at 10 per cent while Europe came in slightly lower at 7.6 per cent. The Japan market posted a return of 17.7 per cent and the Pacific ex-Japan posted a slim 0.6 per cent.

“The recent strong equity market returns have been supported by growing earnings and increasing expectations for future earnings,” explained SSGA’s Toby Warburton, global head of portfolio management, systematic equity-active.

“While this earnings growth had been concentrated in US mega-cap technology-enabled companies, it has been broadening out more recently.“

However, Warburton highlighted that the rate of revisions in analysts’ earnings forecasts over the most recent quarter has been slowing relative to the end of last year. While still positive in many markets globally, in some regions, earnings are expected to decline, he said.

“Although valuations have become a little more expensive this year, they are not extreme, but will require continued robust earnings to support them,” Warburton explained.

Developed markets, in aggregate, are currently priced at around 19 times earnings expectations for the next 12 months, compared to 17 times at the end of 2023, while most markets outside the US sit at a valuation discount to US equities.

“An investor would only need to pay 12 times the next 12 months’ earnings to buy emerging markets exposure, for example, as of the end of March,” Warburton elaborated.

“For the more expensive parts of the market, the risk of slowing earnings momentum is something equity investors should watch closely.”

He added that in recent years, equity markets have shown heightened focus on specific drivers such as trade tensions, AI advancements, and inflation, resulting in increased correlations among stocks, potentially creating a winner-takes-all market scenario and posing challenges for active stock picking strategies.

“We can measure this trend through calculating an average pairwise correlations across all stocks within the market. Encouragingly, there are signs that so called pairwise correlations between stocks are starting to roll over again,” Warburton observed.

“The exact driver for these changes is hard to pinpoint, but recently, many investors have started to anticipate a higher-for-longer rates environment. In this regime, higher debt servicing costs for companies and tightened financial conditions may well push investors back towards fundamentals and away from the higher-level macro and thematic positioning.

“A reversion towards the long-term mean correlation could benefit stock picking strategies, with markets interested in company fundamentals and idiosyncratic characteristics once again.”

Cross-sectional dispersions, which measures the spread of returns between stocks, is another useful variable to assess the market environment, he said.

“In the post-Global Financial Crisis (GFC) period, dispersion was unusually low, before picking up again in 2018–19 and into the COVID period. After a brief dip, there are signs that dispersion is picking up again back towards long-term average levels.”

He opined that this higher dispersion could be beneficial for active managers, as it implies higher differentiation between returns for the winners and losers, and therefore higher active returns for skilled investors.

Interestingly, the latest iteration of its SPIVA Australia Scorecard report, which measures the performance of Australian actively managed funds against their respective benchmarks, found both international and Australian equities struggled to beat their respective benchmarks last year.

Amid the “best of times and the worst of times” for actively managed funds, according to S&P, international general equity funds struggled the most throughout 2023.