Thought Capital
Putting Today’s Market in Context
For investors, the last four years have seen some remarkable events, which have had a profound impact on equity markets globally. Volatility has been elevated on both the up and down sides. The global pandemic that began in early 2020 induced a sharp correction as the initial curtailment of day-to-day activity became apparent. This reversed quite rapidly with many listed companies posting outsized gains as they benefitted from changing behaviors.
As the pandemic waned, various COVID-era government stimuli, supply chain issues, and the Russian invasion of Ukraine brought a resurgence of inflation after many years of muted price rises and historically low interest rates. Mandated with controlling inflation, most major central banks had little option but to embark on a rapid and sustained program of monetary tightening, which was a novel experience for many market participants.
Throughout 2022, the growth equity universe of companies experienced rapid drawdowns as the present value of future earnings were repriced, with little attention paid to differentiating between companies with established high and steady levels of revenues and profits and those much more speculative in nature.
While 2023 saw a return to rewarding robust fundamentals, equity market returns have been distorted by a handful of companies, predominantly in the technology space. Through the third quarter of the year, approximately 92% of the S&P 500 Index’s market return was accounted for by the top ten holdings, as shown in Figure 1. The factors behind this unusual phenomenon are varied, in our opinion. In our view, the generally low interest rate environment over the past decade, breakthrough innovations like generative AI, the emergence of platform businesses, and winner-take-all (or most) market dynamics are all contributing factors. Index concentration is also visible globally, with ten stocks accounting for 65% of the MSCI ACWI Index return over the same period.1
Figure 1: 92% of the S&P 500 Index Return from Ten Stocks
Source: Bloomberg. Reflects top ten contributors to the S&P 500 Index return from 12-31-2022 to 09-30-2023. Past performance cannot guarantee future results.
Recent near-term volatility, driven largely by macroeconomic and political events, has presented challenges for long-term, fundamental investors like us. As always, however, we must look to the future while learning from the past. We must remain diligent and patient when the market is temporarily not rewarding the businesses with the most robust, durable fundamentals.
Looking Ahead in Large Company Growth: Key Takeaways for Investors
In 2024, we will continue to spend the bulk of our time analyzing and understanding companies and their competitive environments.
We invest only in what we believe are the most competitively advantaged businesses in the world—a highly focused cohort of companies that, according to our research, are well positioned to drive the mid-teens EPS growth we seek across our portfolios.
Our experience shows that by focusing on what we believe to be high-quality companies and getting our earnings growth predictions directionally right, the share prices for these businesses should follow earnings growth over the long term. We remain very much on track to achieve this in our large company portfolios over the next three to five years.
Today, the broader index returns are far outpacing the underlying earnings growth of the constituent companies, which suggests that multiple expansion is having an outsized effect on performance. We believe a credible case exists that equity market valuations may revert to their long-term average. If so, this would imply that earnings growth could be a much larger component of future total returns compared to the past decade.
Important Disclosures
1Source: Bloomberg, as of September 30, 2023.
This information is provided for illustrative purposes only. Opinions and views expressed constitute the judgment of Polen Capital as of November 2023 and may involve a number of assumptions and estimates which are not guaranteed, and are subject to change without notice or update. Although the information and any opinions or views given have been obtained from or based on sources believed to be reliable, no warranty or representation is made as to their correctness, completeness, or accuracy.
Opinions, estimates, forecasts, and statements of financial market trends that are based on current market conditions constitute our judgment and are subject to change without notice, including any forward-looking estimates or statements which are based on certain expectations and assumptions. The views and strategies described may not be suitable for all clients.
This document does not identify all the risks (direct or indirect) or other considerations which might be material to you when entering any financial transaction. Past performance does not guarantee future results and profitable results cannot be guaranteed. The volatility and other material characteristics of the indices referenced may be materially different from the performance achieved by an individual investor. In addition, an investor’s holdings may be materially different from those within the index. Indices are unmanaged and one cannot invest directly in an index.
Definitions:
The S&P 500® Index is a market capitalization weighted index that measures 500 common equities that are generally representative of the U.S. stock market. The index is maintained by S&P Dow Jones Indices.
The MSCI ACWI Index is a market capitalization weighted equity index that measures the performance of large and mid-cap segments across developed and emerging market countries. The index is maintained by Morgan Stanley Capital International.
EPS Growth measures the rate at which a company’s earnings per share (EPS) is increasing or decreasing, expressed as a percentage.