Markets at a crossroads

Wide return dispersion, easy capital and why investors should stay focused on fundamentals

Key points
- Wide divergence in market returns
- Loose capital
- Downplay the macro headlines

After a rip snorting rally, markets had a more subdued month, reminding us that there can be big differences in returns and AI is not the only game in town. Instead of a rise in most sectors and countries, we saw both losses and sizeable gains. We made money on our healthcare exposure which we hold as a diversifier and for growth as well as Korean equities where we retain a modest overweight position.

The big attention grabber was of course the man with the world’s biggest megaphone (Elon Musk) shooting for the stars with an audacious capital raising for SpaceX. Our Morningstar Equity Research colleagues pointed out that the float price for that IPO baked in way too much optimism and it is no surprise that after its brief blast, gravity has taken hold and pulled the price back down again. We suspect though that this is closer to the start than the end of a period of easy capital. Expect more capital raisings from in vogue companies tapping equity and debt markets. For the first time in 5 years the investing public are directly involved in funding new investments, not just private capital and the hyperscalers reinvesting their profits.

Our own metrics tracking equity capital supply are very clearly showing conditions easing, meaning that it is becoming much easier to raise larger amounts of money on terms that are more favourable to companies than investors. To be fair it is not on a par with peak speculative episodes in 2021, 2006 or 1999. This time it is dominant franchises or leaders that are seeking funding, SpaceX raised about
$85bn, Alphabet $80bn and Korean chipmaking giant SK Hynix $26bn. More is to come with IPOs expected for Anthropic and OpenAI plus fintechs including Revolut and Stripe.

In South Africa we have not seen any sizeable capital raisings, with net delistings being an especially evident trend on the JSE over the last 10 years. Capital supply tends to be especially cyclical and largely dependent on business confidence and investor sentiment – both attributes that have not been particularly strong in domestic markets over the last few years. That does not detract from the stellar performance of the SA equity market over the last year where we were able to take profits from sentiment driven rallies in resource companies earlier in the year.

On the geopolitical front, there continues to be uncertainty in global energy markets, as the conflict between the US and Iran shows little sign of abating. The sharp rise in oil prices has been beneficial for the global oil majors, which has been a positive contributor to the performance of our funds, where we have held a dedicated position to European Energy counters throughout the conflict. In textbook economics fashion, the global energy industry has responded to high prices with massive investment and surging supply of oil and gas. Demand has eased as big importers have become both more energy efficient and turned to renewables. All of this means geopolitical energy supply shocks are less potent, lessening their impact on inflation and the scope to supercharge oil and gas profits.
 
But the bigger point about geopolitical risks like the US-Iran conflict is that their impact is mostly fleeting and they are simply not predictable. If investing is about getting the odds on your side, then it is better to focus on the fundamentals that drive longer term inflation, interest rates and corporate earnings growth rather than geopolitics. You do need to understand how the economic and political environment is evolving but the keys to generating return and managing risk remain fundamental diversification, broad research and favouring undervalued investments. K

Risk Warnings
This commentary does not constitute investment, legal, tax or other advice and is supplied for information purposes only. Past performance is not a guide to future returns. The value of investments may go down as well as up and an investor may not get back the amount invested. Reference to any specific security is not a recommendation to buy or sell that security. The information, data, analyses, and opinions presented herein are provided as of the date written and are subject to change without notice. Every effort has been made to ensure the accuracy of the information provided, but Morningstar Investment Management South Africa (Pty) Ltd makes no warranty, express or implied regarding such information. The information presented herein will be deemed to be superseded by any subsequent versions of this commentary. The commentary is not guaranteed to occur. Except as otherwise required by law, Morningstar Investment Management South Africa (Pty) Ltd shall not be responsible for any trading decisions, damages or losses resulting from, or related to, the information, data, analyses or opinions or their use.

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