Market news today - where next, a year on from the low?

THE 2022 bear market ended almost exactly a year ago, itself a year after shares had peaked at the end of the post-pandemic rally. So where next, now that shares have bounced by 25% over the past 12 months?

Earnings and valuations

The market equation has two key parts - how fast profits are growing and the price investors are prepared to pay for a share of that growth. This week the latest earnings season - covering the July to September quarter - kicks off so we should soon have a clearer idea of whether still optimistic forecasts for 2024 and 2025 earnings remain plausible.

The second part of the equation is trickier to judge. What is the right valuation multiple for the market ahead of a possible economic slowdown on the back of the past 18 months of sharply rising interest rates? The US market trades on about 20 times expected profits. That seems to offer little scope for further gains. Other markets are much more reasonably valued.

Even within the expensive US market, it’s not a simple story. An equal weighted version of the S&P 500 index has gone sideways for two years. That’s not what you’d think looking at the headline index, which has been driven higher by a handful of tech stocks - what we have started to call the Magnificent Seven. The picture is different again if you look at smaller company shares. These have been falling fast since 2021.

Nifty Seven

It’s all quite reminiscent of a couple of earlier periods of market dominance by a small number of high-performing stocks. Back in the early 1970s these were branded the Nifty 50. In the late 1990s it was just called the tech bubble. So, if we are in a new Nifty Seven period, how long might it go on for and what might be the trigger for a shift back to the rest of the market?

The 1970s period was very much a flight-to-quality period. Investors bought what they could trust in a difficult economic environment. There’s an element of that today too as investors worry about a possible recession, higher for longer interest rates and sticky inflation.

In the 1990s it was more about valuations. Today, too, the tech giants are much more highly valued than other shares but the gap between the two is nowhere near what it was in either previous episode when the popular shares were valued twice as highly as the also-rans. Today the ratio is closer to 1.4. By itself that argues that the tech stocks could dominate for a while longer yet.

One thing we do know, however, is that market trends go on for multiple years and then go the other way for extended periods. When the Nifty Seven stop being the only place to invest, everything that has not worked in recent years may start to do so - non-US shares, commodities, smaller companies, value rather than growth focused shares.

We are not there yet, but the odds of a rotation to out of favour areas of the market are improving. This is a good time to be well-diversified so that your portfolio is not caught out by the shift when it comes.

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