So far this year we have seen one of the strongest periods for momentum on record. This presents risks, and we are proceeding with caution. The good news is that this environment also presents lots of good opportunities for us to take advantage of as we prepare the portfolio for what’s next.
What is momentum?
Stocks that are rising faster than the overall market are said to have momentum. Momentum investors believe that stocks that have outperformed recently will continue to outperform in the near term.
Today, such stocks include any companies that are deemed to be an “AI winner,” US banks, and European defence and global aerospace companies.
Investors are focused on momentum
To us, it feels like company earnings and stock price momentum are some of the only things that matter to broad swathes of the market. Well over half of the market’s trading volume is now done by investors who are momentum focused with shorter time horizons.
Other attributes such as valuation (whether stocks are “expensive” or “inexpensive” based on how much a company earns) and quality (stocks that rank highly on measures of financial strength and stability) are very much secondary.
Preparing for what’s next
The most important momentum debate today, in our minds, is whether we are in an AI-driven bubble. Many exceptionally smart participants are weighing in on both sides of the debate. Unfortunately, it is almost impossible to predict when the momentum might shift away from AI stocks, but we believe it pays to be prepared. As such, we are preparing the portfolio for a wide range of potential outcomes, as discussed in the below portfolio stock examples.
- ASML shares reached an almost decade low price-to-earnings ratio - a simple way to see how expensive a company’s stock is compared to the money it makes - earlier this summer (meaning that the stock was inexpensive compared to the company’s earnings). We used this opportunity to build a large position in what is, in our view, an exceptional company. In the space of a few weeks, the market has gone from fretting about demand for ASML’s tools to once again perceiving ASML as an “AI winner.” We were delighted to be able to make ASML a material position at what we see as an attractive valuation.
- London Stock Exchange (LSEG) has seen its price-to-earnings ratio fall dramatically as the market has chosen to view it as a company that will be disrupted by AI. But we believe it’s more likely that LSEG’s valuable datasets and deep connections will prevent this kind of disruption. In fact, LSEG could well benefit from their partnership with Microsoft as they work to innovate faster and accelerate revenues. Additionally, LSEG’s earnings have continued to compound (meaning they’re generating returns not only on the original amount but also the previous returns that have already accumulated) nicely.
- UMG saw its price-to-earnings ratio fall as the market became fretful about AI musicians disrupting listening habits. But we believe it’s more likely that consumers will continue to want to connect with human musicians rather than shifting substantially to AI.
- New holding Elis fits more into the “neglected” category because it isn’t in an exciting corner of the market. Elis is involved in laundry - specialising in the rental, cleaning, and maintenance of textiles and workwear. Elis pays a healthy dividend yield and we think it is safe to say that Elis is unlikely to get disrupted by AI. This is a business that to date has managed to efficiently lower costs and increased profit margins with scale. We were happy to buy this stock at what is, in our view, an attractive valuation.
- Rolls Royce continues to go from strength to strength as the market appreciates the quality of the civil aero franchise and the potential for continued profitable growth there. There is continued potential for high and continued long-term earnings growth thanks to its exposure to rapidly growing European defence spending and nuclear small module reactors (involved in meeting power needs for AI).
- Chicago Mercantile Exchange (CME). We sold the remainder of our holding in this stock to fund what we see as more attractive opportunities elsewhere. We like CME’s business and will continue to monitor the stock.
- Analog Devices (ADI). We think ADI is a great company with innovative products and exceptional profit margins. However we sold the remainder of our holding to fund what we view as more compelling opportunities elsewhere in the sector attractive opportunities elsewhere.
