The European stock index Stoxx 600 recorded its worst relative performance compared to the American S&P 500 since 1995. The MSCI World Index, which represents around 1,400 companies from 23 industrialized countries by market capitalization, achieved an excess return of 11% compared to the same index with equal weighting of stocks, also a record value. A key factor behind these differences is that the world’s eight largest companies*, all headquartered in the United States, now account for more than one-fifth of the MSCI World Index. In 2024, they contributed 40% to the index’s performance. Their impact is even more pronounced in U.S. indices. The current economic environment is challenging, which makes growth particularly valuable and expensive. Leading technology companies benefit both from their dominant market position and the general technologization. The profit and valuation development of these companies, as well as their high share of the total market, reflect these trends.
Regional Developments and Political Changes
At the same time, economic prospects vary significantly in different parts of the world. In Europe, economic problems have shifted from the periphery to the center. France now faces similarly high interest rates on government bonds as Greece due to problematic state finances and tense domestic political conditions. Germany is grappling with various economic and political challenges. Its negative economic growth stands out clearly both in European and international comparisons. The fact that the German benchmark index DAX remains largely unimpressed is mainly because the companies included in the index generate a large share of their revenues abroad and benefit from a weak Euro. China’s economic development continues to fall well short of expectations. The weakening real estate market is weighing on consumption, which cannot be sufficiently offset by exports. Comprehensive measures have now been announced to stimulate the economy again. Whether these will be sufficient also depends on how seriously the U.S. government takes possible import tariffs.
With Donald Trump’s clear election victory, the U.S. has opted for a decisive policy shift both domestically and abroad. Deregulation and tax cuts are intended to bolster competitiveness, while Elon Musk is to ensure the stabilization of state finances. Given that interest expenses are now higher than total military spending, this idea is not far-fetched. The case of Argentina illustrates how swift and bold reforms can drive change, as initial signs of progress emerge through deregulation and the streamlining of government bureaucracy is revitalizing the nation’s economy. In Europe, a comparable development is not yet foreseeable. From a market perspective, it will be interesting to see how the different policy paths affect economic growth, which already differs greatly. Positive economic impulses can be well-used in the current environment, regardless of their geographical origin, and are in the interest of all investors.
Valuation Discussion and Company Analysis
In addition to economic differences, valuation disparities between the USA and Europe are among the most discussed topics currently. Based on our own evaluations and experience, however, regional valuation discussions are too narrow. The sector composition of the two regions is very different, and the dominance of the large technology corporations distorts both perception and the valuation of the technology sector and the overall market. Upon closer examination, one finds that there are hardly any two companies that can be directly compared. Lindt is not Hershey, and SAP is not Microsoft. Even when two companies have similar products, like Adidas and Nike, there are differences in sales markets and company-specific challenges. Accordingly, we assess each company individually in terms of quality, track record, and valuation. Within our investment universe, we see no significant regional valuation differences that cannot be explained by economic and company-specific factors. Internationally active companies with market-leading products and services adapt to global challenges and are often more agile and less restricted in their decision-making than investors. We take this into account by investing in companies with a leading market position regardless of the location of their global headquarters.
Conclusion and Outlook
While the dominant tech companies now reflect high expectations in their valuations which they must meet in the future, we find companies worldwide where this is not the case. Should the growth differential between major corporations and the rest of the market narrow, which is statistically likely, it could have a noticeable impact due to the high expectations already priced into valuations. In the medium term, we consider it realistic to see a return to the long-term trend in which equally weighted indices outperform those weighted by market capitalization. Any positive economic surprises could serve as a catalyst for this shift by enabling more broadly based earnings growth. Conversely, it is possible that the revenues and earnings of the dominant technology companies will fail to meet lofty expectations, leading to a corresponding correction in valuations.
Currently, a passive investor is more dependent than ever on the stock performance of just a few large corporations. Active asset management, on the other hand, offers the opportunity to invest selectively where quality and valuation are in an attractive ratio, without relying on the realization of high growth expectations. In times of heightened uncertainty and concentration risks, we believe that discipline and an active approach are especially rewarding. With confidence in our principles and strategy, we look to the future with steadfast optimism.
Zurich, end of Dezember 2024
*as of 31 December 2024: Apple, Nvidia, Microsoft, Amazon, Meta, Tesla, Alphabet, Broadcom (excl. Saudi Aramco, as it is not part of the MSCI World)
With the euphoria surrounding the topic of artificial intelligence and the strong performance of the technology sector since the end of 2022, concerns have grown that the sector may now be too expensive. The issue in assessing this question is multifaceted. The technology sector consists of the three sub-sectors: software, hardware, and semiconductors. Each of these three sub-sectors has different demand dynamics, margin profiles, growth rates, and valuations. Both the sector and the sub-sectors are dominated by Apple, Microsoft, and NVIDIA, which together make up about half of the technology sector with market capitalizations of several trillion USD each. Since 2018, large technology companies like Alphabet (formerly Google) and Meta (formerly Facebook) have also been allocated to the communication sector rather than the technology sector. Broad overall assessments at the level of an overarching sector do not do justice to these circumstances.
The same can also be said for regional evaluations. A statement like ‘Europe is attractively valued compared to the USA’ is not meaningful without considering the different composition of the sectors. While in Europe the finance and industrial sectors each account for about 15% of the total, in the USA the technology sector, with around one-third, is by far the most significant sector. It is undisputed that the financial sector, especially since the financial crisis, does not have the best track record, while the technology sector continues to gain importance. From the trend towards smartphones, cloud computing, and most recently artificial intelligence, no consumer and no company can escape digitization. Accordingly, their share of economic output has increased, which is rightly reflected in market capitalization.
For a specific assessment of valuation, the widely used price/earnings ratio falls short. The price reflects not only the current earnings but also their growth prospects. The entire technology sector shows a significant growth premium compared to the overall market. Especially in economically challenging environments, this is valuable and essential to at least keep pace with inflation. Thus, a valuation premium based on current earnings compared to the overall market is justified.
Additionally, important is that profit growth can be achieved both through revenue increases and efficiency gains. The latter, due to scalability, leads to above-average high margins in the technology sector. According to our assessment, these could be even higher, especially for the large technology companies, since efficiency was not a priority until recently due to strong growth.
Considering all the above-mentioned circumstances, the valuation of the technology sector has indeed become more demanding compared to the overall market. At the same time, the excess growth has accentuated in the current environment. Occasionally, future expectations regarding artificial intelligence may have led to valuations that have somewhat outrun earnings development. Overall, we consider the valuation to be in an appropriate relation to the growth.
As active investors, we have the privilege of not having to buy the entire sector. Our focus is exclusively on finding companies where the earnings prospects are in an attractive relation to the valuation.
Zurich, end of March 2024