Satrix reports that in July 2024, small-cap stocks outpaced big tech, with the Russell 2000 Index, which tracks small-cap stocks in the US, outperformed the Nasdaq Index by 11% in July. The Nasdaq Index now outperforming the Nasdaq by 11%. Explore the reasons behind this shift, the importance of diversification, and why maintaining a long-term perspective is crucial for investors.
It’s Information Technology stocks have been the biggest driver of equity markets in the last 24 months, with some even earning the “Magnificent Seven” status. The Nasdaq 100 Index houses these trendsetters, with the stocks occupying almost 50% of the total weight of the index. With most of these stocks reaching all-time highs in recent months, it is not surprising that the Nasdaq Index has been dominating market returns lately.
However, in July there was a huge swing from high-growth large-cap stocks (which the Nasdaq 100 Index holds) to market participants searching for pockets of opportunities elsewhere, and the small-cap sector provided these opportunities.
In offshore markets, the Russell 2000 Index, which tracks small-cap stocks in the US, outperformed the Nasdaq Index by 11% in July. The Nasdaq Index now leads the Russell 2000 Index by close to 10%, whereas it began the year leading by close to 43%, on 12 month-rolling returns.
Locally, small caps have led the way since the beginning of the year as well, with the FTSE/JSE Small Cap Index up 15.5% so far this year, trailed by Financials and Listed Property stocks which are tied at 14.4%. The FTSE/JSE Large Cap Index is up 8.9%, mirroring the offshore underperformance of large caps against small-size companies recently.
Firstly, Why the Shift?
One month worth of returns doesn’t necessarily tell the full story. In as much as the markets witnessed some sort of rotation out of tech stocks into small-size companies, this was observed over a short period. The logic behind this trend is that when interest rates fall, which market commentators predict will happen in September in the US, then the rate of borrowing is lower, helping smaller counters to service their debt better. But the landing needs to be soft, as they’d place all reliance on a healthy economy to keep profits going. The other side of this trade came from the Bank of Japan raising interest rates by 0.25%. This led to the rapid unwinding of Japanese Yen carry trades by investors trying to avoid losses from a strengthening Yen. Carry trades involve borrowing funds in a currency with low interest rates, such as the Japanese Yen, and investing them in a currency or asset offering higher returns. As the Yen strengthened, investors scrambled to exit these trades to mitigate potential losses.
In terms of valuations, tech stocks have been stretched, and in an environment where the interest rates are lower, their valuations are even more stretched.
Some investors may be taking some profits from these high-growth stocks while also finding value in neglected sectors in the markets.
Navigating Risk
Market turbulence tends to cause investors to be nervous, and to seek short-term solutions – thereby locking in losses by selling out prematurely from their positions and attempting to time the market. In 2022, the Nasdaq Index closed the year down 28% in rand terms over the 12-month period. Yet anyone who stayed invested would have made up all of their losses within the first two months of the following year, as the index rose 1%. The index ended 2023 up 66.3%.
Diversification tends to be the solution in navigating market risks, by spreading investments across asset classes, sectors, and geographies. This helps reduce the impact of poor performance from a single investment. The other crucial part of one’s investment journey is always maintaining a long-term perspective.
Impulsive decisions based on short-term market movements tend to have consequences – locking in losses and investing in asset classes which are only showing short-term relief. The mathematics of making up your losses can be brutal; losing 75% of your value and locking in that loss would mean that you need to find an asset class that will give you 300% returns right away, to just break even.
Diversification in the Real World
While US large caps were going head-to-head with small caps, other asset classes and sectors also had an eventful July. The rand continued to strengthen against the dollar last month, appreciating by 0.4% to close the month at R18.19. The JSE All Bond Index was one of the strongest performing assets during the month, up 4.0% while the STEFI cash index was up 0.7%. The price of gold trended upwards during the month, rising 5.1% in dollar terms and closed at US$2445.70. As an asset class, gold has done exceptionally well this year through the high market volatility.
Global bonds were up 2.4% for the month, as the US 10 Year Treasury Bond Note Yield came down from 4.4% at the end of June to 4.0% at the end of July. The MSCI World Index was up 1.4%, doing better than the MSCI Emerging Markets Index which ended the month down 2.2%, largely driven by equities’ underperformance in China as the MSCI China Index fell 1.7% for the month. On the other hand, the MSCI India Index continued to outperform, rising 3.6% and the MSCI UK Index and MSCI Euro Index were up 3.8% and 1.8% respectively, all in ZAR.
With all these different asset classes and regions performing differently, diversification is not only about looking at one asset type or jurisdiction - it is about considering all options available.
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