Equity investors may have recovered some of their confidence, but the hard numbers keep telling us a very different story – which is that investors are worried and are pumping more and more money into bond funds. The first chart below is from the European Fund and Asset Management Association (EFAMA) and shows just how pronounced these inflows are to bond funds. US investors, in particular, seem to have become aggressively much more cautious. But for me, the interesting sub-story is that investor interest in emerging market bonds is steadily increasing, admittedly from a low base.
I think it is fair to say that most investors now roll their eyes when they keep hearing how important emerging markets are to the world economy. They’ve heard the story a million times before. But the second chart below from Wells Fargo reminds us that just because we keep hearing the same story, doesn’t mean it’s not true. Quite the opposite in fact – emerging markets are a constantly growing proportion of world GDP. Given this undeniable fact, it’s hard to understand the narrative behind the third chart, also from Wells Fargo. It shows average sovereign debt yields for EM nations as well as developed countries. Real yields haven’t much moved in the developing world and are still well above 2% per annum. In the developed world those real yields are cruising close to zero and in some countries clearly negative. Most emerging market sovereigns are still growing fast, feature younger demographics and have lower debt levels yet the yield they pay on their debts hasn’t budged much. EM bond managers keep muttering about this strange state of affairs, but bond investors don’t seem overly concerned – as they keep buying into safe haven developed world sovereign bonds.
Equities – Polarised markets
June was another good month for equity markets as global markets uniformly turned around from last month. According to S&P Dow Jones, June posted a broad gain of 6.20% after Mays broad decline of 6.20%, which was after April’s broad gain of 3.11% (March was up 0.78%). Over the one-year period, global markets were up 2.42%, and absent the U.S.’s 6.85% gain, they were off 2.34%. Longer-term yardsticks continued to show the U.S. outperformance pattern, as the two-year global return was 11.69% with the U.S. (20.40%) and 2.86% without it, and the three-year return was up 30.57%, and absent the U.S. (39.90%) it was up 20.99%.
But within this broad positive trend, there’s a worrying pattern emerging. Sure, global equity markets look to be in reasonable shape as we head into what must be a late part of the cycle. But these gains are not being evenly distributed. Quite the opposite in fact. More money than ever is flooding into large cap funds, and that in turn is pushing up mega cap valuations. But this uneven distribution of flows – and gains – is arguably even more extreme than it first appears. There is growing evidence that just a handful of global businesses – dozens, or at most hundreds – are capturing the vast majority of the gains.
One way of seeing this in action is to watch the returns from equal-weighted versus market cap-weighted performance. The idea here is that it is clearly healthier for the majority to be outperforming the more concentrated large cap-tilted index and of course passive and associated top-down flows favour market cap rather than equal-weighted ones. According to equity analysts at French bank SocGen, these indices are telling a very different story. In 2018 and again this year, the MSCI World equal-weighted index has slumped versus the more closely watch market cap index. “In other words, a majority of companies are struggling”, according to SG. The chart below splits a very large global universe of 17000 stocks into market-cap grouped portfolios and measures their median annual performance over the last 12 months.
According to SG “the mega-cap group (i.e. those above USD100bn) is powering ahead whilst those in the sub-1bn market cap range are still struggling to make back last year’s loss. The more remarkable numbers are that this 100bn portfolio represents just 77 companies but 27% of the global market cap.…. our increasing focus on a few large-cap indices populated by just a fraction of the world’s companies is giving investors a false impression. Corporates are struggling!”