With the stock market whales remaining dominant (and several becoming even bigger), 2024 has been tough for the minnows. The global small cap index trailed the large cap equivalent by around eight percentage points at the end of August as investors have continued to shun smaller companies in favour of tech giants linked to Artificial Intelligence[1].
These ‘Magnificent 7’ make up 30% of the US S&P 500 index, while in Europe, ten stocks (aka ‘the GRANOLAS’) represent a quarter of the overall market[2]. The narrowing of returns has also distorted valuations to the extent that global large caps now trade at a record 12% premium to smaller ones on a P/E basis, compared to an average 12% discount over the last two decades. The ‘magnificent gap’ between the largest US technology companies and global small caps is even wider and approaching a 50% premium.
Stock market normalisation?
There have been some signs recently, however, that appetite for these expensive growth stocks is starting to fade as investors question when they will see returns on their huge investments in AI. The Magnificent 7 have underperformed the US market since June and are collectively down around 10% from their summer highs. Nvidia (-12%) has led the correction with doubts about the sustainability of its revenue growth compounded by the CEO and other insiders selling a significant number of shares[3].
Lower interest rates could also act as a near-term catalyst for equity market normalisation with the Federal Reserve odds-on to follow the ECB and Bank of England in cutting US borrowing costs later this month. The anticipated rise in economic activity would be especially positive for cyclical value stocks, while smaller companies, which tend to have more floating rate debt than larger ones, would also benefit from cheaper financing costs.
Value outperforming growth once again would mark a normalisation for stock markets in a historical context. Growth has been dominant since 2022 and previous such phases (marked 1 and 2 in the chart below) have been followed by strong reversals in favour of value companies.
Value focus
Despite these headwinds, SKAGEN Focus outperformed the MSCI All Country World Index in both 2022 and 2023, although it lags the same benchmark by 14 percentage points this year. This leaves its small-cap, value-biased portfolio with an estimated upside of 76% – a level last seen at the outbreak of the pandemic that kick-started Focus returning 131% in EUR terms to the end of August, over 30% ahead of the MSCI AC World Index over the same four and a half-year period.
The portfolio continues to perform well with a healthy turnover of holdings competing for inclusion; 39% of positions have been in the fund for less than 12 months. Eight companies have exited in 2024 after hitting our price targets, including Danaos, Iveco and Phinia, with the latter two providing the fund’s best contributions this year. These have been replaced by Kalmar (a recent spin-off from Cargotec), Hyundai Mobis (a Korean automotive supplier), Acerinox (a stainless-steel producer) and Akatsuki (a Japanese gaming developer); four exciting new entrants with estimated upside of between 60-110%.
Our value focus is illustrated by the portfolio currently trading 47% and 81% below the MSCI All Country World Index on an earnings and book value basis. A comparison of the same multiples against 330 active global equity funds by Copley Fund Research also highlights our position among the cheapest, while our placing at the top of the distribution for dividend yield reflects our preference for cash generative, shareholder-friendly companies.
With valuations at rock-bottom and the economic outlook improving, value stocks and small caps look well-placed to prosper. Against this backdrop and a return to a more normalised equity market, SKAGEN Focus is in a sweet spot to generate positive absolute and relative returns.
To hear more about the outlook for small and mid-cap companies, a replay of our recent SKAGEN Focus webinar is available here:
NB: All information as at 31/08/2024 unless stated.
[1] Source: MSCI. MSCI ACWI Small Cap (+8.7%) vs. MSCI ACWI large Cap (+16.8%) in EUR 31/12/23 – 31/08/24.
[2] Magnificent Seven: Meta, Amazon, Apple, Microsoft, Google, Tesla, NVIDIA. GRANOLAS: GSK, ASML, Nestle, Novartis, Novo Nordisk, L’Oreal, LVMH, AstraZeneca, SAP, Sanofi.
[3] Source: Bloomberg. Bloomberg Magnificent 7 Total Return Index 10/07/23 – 30/08/24.