May wrap up - a strong month with performance concentrated in a small group of powerhouses

10 June 2024 / Published in News & Stories

Read the ASB Investment Team's monthly wrap up on markets and what it means for your ASB KiwiSaver Scheme investment.

It has been a strong year for growth investors this year with shares performing well. For May this theme continued with the MSCI World ex Australia share market index (hedged into New Zealand dollars) gaining 4.1%.

This performance was more impressive given that interest rates, which had fallen intra month, ended back roughly where they started. Ten-year US government treasury rates, for instance, started the month at 4.7% and ended at 4.5%. Inflation continues to be sticky and central banks, including our own Reserve Bank, remain vigilant and are holding the line, denying investors' hopes for cuts to official interest rates. This meant that returns of income producing assets (such as bonds) lagged growth assets (e.g. shares) during the month.

It was, once again the performance of the Artificial Intelligence (AI) juggernauts, the trillion-dollar companies dominating this revolution, that drove shares higher for the month. 

The poster child for this is Nvidia, a producer of Graphics Processing Units (GPUs), the silicon chips powering the models underpinning AI. Nvidia posted yet another massive profit for the quarter, beating analyst expectations and raising future forecasts. Its share price was richly rewarded rising 26.9% for the month.  In the following two days of its profit announcement its share price was up 12.1%, adding almost US$300b to market value. This is 3 times the total value of all companies listed on the New Zealand share market. 

US market researcher Jim Bianco1 noted during the month that Nvidia alone has been responsible for over a third of the S&P 500's gain for the year to date. Adding the performance of Amazon, Meta Platforms (the owner of Facebook and Instagram) and Microsoft to Nvidia's performance explains over half of the market's return. That doesn't leave much of a contribution for the remaining 496 companies! 

This is clearly a very concentrated market. 

Should we be concerned?

Some market commentators have, understandably, raised concerns that the market is dominated by a small handful of massive companies that have been responsible for the bulk of the market's performance, and that this points to future downside.

Concentration in and of itself, in our view, is not necessarily a problem. Research by US investment bank Goldman Sachs2 illustrates this well. They found, after examining the US S&P 500 over the past hundred years, that the market typically rises more in the 12 months after instances of peak concentration. 

Where we get concerned is valuation. Determining the right price or value for AI companies like Nvidia is difficult. The range of future outcomes is wide. Will Nvidia continue to dominate the AI GPU market, or will competition emerge? Will pricing for these expensive chips come under pressure? Will technology change? Will the approaches to training models versus running them in production mean different, cheaper chips can be used? There are a lot of very difficult if not impossible things to consider to truly understand the future profitability and hence value of Nvidia.

The one thing we do know is the bar that companies like Nvidia need to leap to justify even the current price is getting higher. In short, the market's expectations of future cashflows have risen dramatically and this gives these companies less room for disappointment.  It is certainly not impossible or even improbable that they deliver on this, but it creates risk. 

Alternatives exist?

While the AI juggernaut has marched on other parts of the market have lagged and lagged badly. To see this, we need look no more closely than our own share market. Over the past year to 31 May 2024, the NZX 50 has risen 0.8%, lagging the US S&P 500 by 10.5% in local currency terms. This pattern is seen in other markets or sectors and is particularly evident in those sectors that have been most impacted by rising interest rates. 

We think there are opportunities worth exploring in these lagging sectors, chief amongst these is infrastructure. This fits with our long-term mega trend theme that the world needs considerably more investment in this space. It is somewhat a beneficiary, after a lag of inflation (we just need to look at our own electricity bills to see that) and it has been a relatively poor performer in recent times. 

It looks an interesting candidate to increase in portfolios. Watch this space.

1. https://x.com/biancoresearch/status/1793960860546982377
2. https://www.goldmansachs.com/intelligence/pages/is-the-sp-too-concentrated.html

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