Market leadership - what happens next? (1 of 4)

In the first of a series of articles, Jeremy Podger reviews the areas that have led global equities in recent times. He assesses whether these trends are showing signs of fading and looks back at past “mega-trends” for an insight into what could happen next.

Key take-outs

• There are a number of examples historically of mega-trends that have driven market returns for a prolonged period of time.
• In the last decade or so we have seen three key clear areas dominate - Quality, Technology and Growth.
• Signs are emerging, however, that these trends are changing somewhat and it now seems prudent to consider what this means for future returns.

You can’t step twice into the same river. Stock markets are in a state of constant flux but there are currents that can persist over long periods. Think of the fund manager as navigating a river which is constantly twisting and turning, sometimes calm and sometimes perilously turbulent. At times, one can be positioned in the sweet spot, finding oneself speeding ahead for a while but then, as the river changes course, left behind in an eddying backwater.

We see this in the measurement of “momentum” effects in markets. As long as “momentum” is working, stocks that have performed well in earlier periods have a tendency to outperform subsequently. This appears to have been the case around the world for a very long time (with the notable exception of Japan).

However, the measurement of the momentum effect really only captures shorter term effects. It says little about persistent trends since today’s momentum stocks may be quite different from those of a year ago. So trying to follow a purely momentum-driven strategy would involve a frantic level of portfolio turnover. And occasionally there is a sharp anti-momentum move which will catch out the trader on the way in and the way out and cause huge short-term losses.

Far better then to try to tap into more persistent effects – long term momentum, if you like. Fortunately, at least with the great benefit of hindsight, trends often mirror fundamental earnings power (relative to market averages) and are initially supported – and eventually checked by – relative valuations. Such trends seldom move in a straight line but a manager that sticks with a multi-year theme through thick and thin can appear to be inspired.

Three clear themes have driven markets post-crisis

There are a good many examples of historic mega-trends that have propelled the careers of fund managers. Think of the heroes of the last decade that successfully focused on emerging markets between the end of 2001 and 2010. The MSCI EM Index returned over 300% in GBP terms over those nine years against only a relatively modest rise in developed markets - but over the next five years saw double digit declines as the developed world steadily appreciated. Or, in the middle of that period, the fad for basic materials that fuelled the fantastic growth of China causing, for example, Rio (thanks to its leading position in iron ore) to sharply rise before giving it all back in the second half of 2008.

With this in mind, we need to ask the question about the recent areas of market leadership – have we seen the best of these trends?

In a series of articles over the coming weeks we will look at the three clearest trends that are worth talking about (and they are to some extent overlapping) - Quality, Technology and Growth - and assess whether these areas are now showing signs of fading or reversing.

MSCI Emerging Markets Index performance table

Past performance is not a guide to the future. Source: Datastream, 31 March 2018. Total return in GBP.