Global stock indices have been moving sideways for several months without a convincing move up or down that marks some large movements beneath the surface as the nature of winning and losing stocks has changed quite markedly. In this video, we look at what has changed, why, and whether I think it'll continue. This video is sponsored by Trading 212, a UK zero-commission investment platform. Let's begin by what we mean by a rotation. Now, this is a situation in which the market overall doesn't move a huge amount upwards or downwards, but under the surface, what's happening is that subsections of the market are aggressively moving up and down. So, that could be particular sectors, or it could be a style of investing, and in this case, it's actually both of those. A visual metaphor which people often use is currents underneath the surface of some still water. So, the surface looks calm, but underneath, there's some kind of whirlpool going on. So, there's a sense of masked turbulence. Now, that's all very well if you've got exposure to the index

as a whole, you don't really care, but if you've got exposure to any of those tilt factors or sectors, then you can be swept away. So, let's look at what's happening right now, and I think it pays to zoom out a little bit so that we set up the recent changes. The trade which has worked incredibly well for two decades now is simply to buy US large-cap growth stocks. Here, for example, I've compared two ETFs. The first one is IVW, and that's a growth ETF. So, it takes a subsection of the S&P 500, and these are stocks whose earnings, their profits, are expected to grow much more rapidly than the S&P 500 as a whole. And I've contrasted that with IVE, which gives you exposure to the value part of the S&P 500. So, these are companies which are undervalued based on some valuation measure like price-to-earnings or price-to-book ratio. Then sandwiched in the middle of those two, the blue line is the S&P 500, and that's got a return which is

somewhere between the two. Now, if we look back much further, over a century, say value is the factor which has worked very well in the past. You buy cheap stocks, you wait, and they outperform. Over the last two decades, however, much of which has been a zero interest rate period. That's not been the case. It's been growth which has beaten value. Now, that's not to say that value would have been a disaster. It wouldn't. You'd have got 6.2% annual return, which is pretty good. But if you'd have gone for growth over that 20-year period, you'd have beaten value by 2 percentage points per year, a huge amount compounded over a two-decade period. But what's notable is that the world pool, the factor change, the rotation, if you like, started on July the 11th of this year. And I've marked a vertical dash yellow line here, and that was the publication of US inflation data. Now, this happens on a monthly basis, and it was this inflation print which pushed the market's expectation about the first

Rate cut from the Fed from 50% to above 90%. So, if I read what the FT said about that the next day, it said US tech stocks fell while small caps surged in late morning trade in New York following cooler than expected June inflation data. So, the NASDAQ fell 1.2% with all of The Magnificent Seven tech stocks except Tesla in negative territory. Nvidia was down 3%, Meta 2.1%, Microsoft 2.5%, and the overall benchmark, the S&P 500, just fell 0.5%. So, a move under the surface triggered by this new inflation data. So, if we follow those two ETFs, value and growth, through this period after that tech peak, notice how value carries on trundling upwards, whereas growth very much moves in the opposite direction, such that the overall S&P 500, sandwiched in the middle, hardly moves either way. So, if we broaden the factors that we now look at, so we've got small cap growth, small cap value, large cap growth, large cap value, and also the

Blends in between notice how the factors at the top of the table were the greatest returns since that peak have been the value flavors of the S&P 500. So, that's large-cap value, value blend, and also small-cap value. The stuff at the bottom of the table is all growth, and if we slice the US market according to sectors, these are industries in the US. Notice how tech comes at the bottom of the table, so that was down about 12% over this 2-month period. Whereas the sectors at the top of the table are interest-rate-sensitive sectors, things like real estate, which was badly beaten up when interest rates were very high, but also quite boring defensive sectors like utilities, consumer staples, and even healthcare. So, while the S&P hasn't been moving that much, you can see that if you look at sectors, if you look at styles of investing, things have been moving very rapidly and also changing direction compared to this two-decade trend that we've seen. Today's video is sponsored by Trading 212 UK zero.

commission investment platform, which I've been using for some time for my fund portfolio. This allows me to buy things and put them into something called a pie. Think of this as a portfolio within a portfolio, which is very easy to rebalance. So, I've got a UK small-cap value quality momentum portfolio, and it's got 12 stocks in it. But if I have to rebalance, it's very easy to do. I just click on one button. Also, with a pie, you can autoinvest. That means that you can automatically set up payments into that pie, which are done regularly without any intervention on your part. And this encourages good investment behavior, which is regular saving, by making it easier to do. In addition to these custom pies, which you build yourself based on investments on trading 212, you can also use a readymade pie. These are either model pies created by professional fund managers, or they could be pies made by the community. In fact, you can publish your own pies so that other people can track them and copy them. Trading 212 also offers lots

of other innovative features. For example, its Trading 212 invest account is a multicurrency account, so you can hold cash in multiple currencies and just convert it once. That means you don't have to convert money back and forth as long as you stay in that currency, and that can certainly save you FX fees. Plus, you'll earn interest in the cash held in those other currencies. Another innovative feature is 24/5 trading. This lets you trade US stocks Monday to Friday, even when markets are closed. So, that includes four trading sessions: pre-market, regular hours, after hours, and overnight. And you can switch that feature off in your account if you don't want it. Viewers of Pension Craft get a special offer from Trading 212, where you can earn free fractional shares worth up to £100. To claim that, simply create your account, verify it, fund it with at least a pound, and then use the promo code, which is my first name, Ramin, R-A-M-I-N, or alternatively, use the link in the description below. Now, why is this rotation happening in the first place? In fact, I think the

question should be turned around, and I'd say, why hasn't it happened sooner? The reason for that is that if you look at the very large Mega cap tech stocks in the US, they're hugely overvalued relative to the rest of the IND index. Here, for example, we can see the forward price-to-earnings multiple. That's the number of dollars you pay for every dollar of forecast profits. And we do that for the Mega cap 8, so that's Alphabet, Amazon, Apple, Meta, Microsoft, Netflix, Nvidia, and Tesla. And if we strip those out of the S&P 500 and look at the remaining stocks, notice how much that pushes down the overall valuation of the index. We go from about 29 times forward earnings to about 19 times forward earnings. So why would people be willing to pay more for every dollar of profit from one of these tech companies than they would from other stocks in the S&P 500? Well, it's a fashion, and it's also a sense of euphoria, and it's driven by a narrative. A lot of that narrative is to

do with AI, and I think what's happened is that people have overpaid for those stocks because of that narrative. Now, narratives are fickle, whereas fundamentals are very reliable in the sense that the market gets snapped back to fundamentals when some kind of shock comes along. Now, in this case, I think the shock has been a macroeconomic one, which is that we've gone from a high-rate environment to something which is more like normal rates. We've gone from an inverted yield curve, and we're about to move to a yield curve which is upward sloping. But whatever the trigger would be, whether it's a macro shock or a scandal, eventually, this was going to correct one way or another. Another balance which I think is interesting to look at is the proportion of profits which those eight stocks make up for the S&P 500 and the proportion of revenue, and contrast that with a percentage of the index they make up. So currently, they make up 30%, let's call it a third of the overall S&P 500, which is very high by

historic standards. It's very concentrated, and at the same time, they only make up a fifth of the profits generated by the S&P 500 and about a 99th of the overall revenue. So, they're certainly punching above their weight fundamentally in terms of their proportion of the overall index, and that's a situation which can't persist forever. And I think the other point is that if you look at the S&P 500, it's full of great companies. They're not necessarily anything to do with AI, but they're profitable, they've been growing their earnings, they've got good strong balance sheets, and these are quite unsexy companies. It's really hard to get worked up about a company like Walmart or Johnson & Johnson or Coca-Cola, one of Warren Buffett's favorites, whereas Alphabet, Nvidia, Broadcom, all of those stocks have been very much driven by this AI narrative. So, I think what we're seeing here is simply a recognition that those are good companies, even though they haven't been very sexy, and the rotation towards value is a nod towards

those healthy companies which are simply undervalued. So now let's think about what could happen next. If I had to characterize 2024, and I think this is the way people will look back on the year in the future, it's the year in which the FED started to cut interest rates after successfully battling inflation. Now, it's not just the FED which has been battling inflation; all other central banks have been doing the same thing at pretty much the same time. But if we look at interest rate expectations for the rest of this year, the 2-year yields from various countries give us a hint about what markets are expecting with the policy rate changes. Notice how for every country other than Japan, those 2-year rates are at pretty high levels because that reflects the high policy rates we've got at the moment, and they're expecting cuts. Notice how they've started falling in almost all of those countries except Japan. So this big macro shift from inverted yield curves, restrictive monetary policy, going to a more normalized policy upward.

sloping yield curves. That's a huge shift that affects the cost of funding for companies, and it affects risk appetite. Now, I think over the short term, what I'd expect to see is an extension of this rotation we've seen already, which is that interest rate-sensitive sectors like real estate, like small caps, where there's a lot of financials, which have lent money to the real estate sector. I think those stocks and sectors will see a boost as interest rates start to fall. However, interest rates won't fall to zero. The expectation is that interest rates will fall, the policy rates at least to around 3%. At the same time, it looks like we're going to get a soft landing. In other words, no huge recession. So for small caps, this looks pretty good. So I'd expect small caps to do pretty well over the medium term, and that's going to be boosted by the huge valuation disconnect between small cap in the US right now and large caps. I don't think I've ever seen such a large difference between the valuation of the

two the small cap S&P 600 index is trading at a multiple of 14.5 times, and that's versus 20.2 times for the S&P 500. So, I think we will see that normalize, and I think rates will probably be a trigger for that. But how about over the longer term once rates have normalized? What then? And here, I think valuations will still matter, and that's because we still see US tech stocks and growth stocks having particularly high valuations relative to the rest of the US market and the US relative to the rest of the world. And it's interesting that Vanguard has just published its 10-year outlook for various stock markets around the world. Notice how for US growth stocks, the outlook is particularly poor. It's between 0.1 and 2.1% growth every year for the next 10 years. Contrast that with US value, that's between 4.7 and 6.7% per year. Small caps between 4.8 and 6.8, and looking outside the US, we're

looking at between 6.9 and 8.9% for non-US stocks. Now, the reason for those forecasts is that US growth is just overpriced. People are paying too much for growth right now, and the penalty which they'll pay for that if they stick with that tilt is simply underperformance relative to those other sectors, other countries which are not so overpriced. Now, of course, we should always take these forecasts with a pinch of salt. They're always wrong, but they are interesting, and I think this one reflects those valuation disconnects that we're looking at right now. Now, as index investors, which I assume many of the viewers of PensionCraft are, you can look at these rotations under the surface and just be confused by it. But what I do see are some people buying more tech stocks because that's what's worked over the last two decades. They assume that that trade will carry on working, but I think that's a pretty dangerous thing to do, doubling down on this huge concentration that we already

have if you own a global index say so. I certainly wouldn't do that. Also, I wouldn't tilt away from the US. I still think it's got very good returns that it can generate in the future. But I think that's the benefit of globally diversifying. You're not going to be that concentrated in one country, and if there is a correction in the US, then at least you'll have that non-US allocation as well to soften the blow. It could be that US growth continues to outperform, so I probably wouldn't take a huge tilt one way or the other. But certainly in my personal portfolio, I've taken a tilt to US small caps and also UK small cap growth value quality stocks because I think valuation long-term does matter. Now, don't forget our offer from Trading 212. You can claim free fractional shares worth up to £100. Simply open a Trading 212 account, fund it, verify it, and then simply use my name R A M I N R O M E N as the promo code or use the link in the

description below, and as always, thank you for listening.

The Great Stock Market Rotation: What's Next?

My name is Ramin Nakisa and I started PensionCraft in 2016 as I felt strongly that I wanted to teach people how to invest well for themselves so they could stop making costly mistakes and losing their money through having to pay unnecessarily high fees.

Before starting PensionCraft, I worked in investment banking as a strategist and I was a frequent contributor on CNBC and Bloomberg TV. I have written two books about finance and investment: one for professional investors and one that explains how to buy and sell volatility using exchange-traded products.

I publish a new video on YouTube every Saturday and you can join me for a live Q&A on the 1st Thursday of every month at 7pm UK time.

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