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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
The writer is founder and chief executive of Trivariate Research
In recent years, the US equity market has been reshaped dramatically by forces ranging from global trade shifts to the rise of AI. Investor strategies need to evolve accordingly.
Some investors might worry about changing their investment approach at the wrong time. But market dynamics have shifted, and ample evidence is in place to conclude that many changes are structural. While there are dozens of examples, here are five themes investors need to pay attention to:
Risk management of the giga-caps. One of the most obvious and striking shifts is the concentration of market power among a few massive companies, the giga-caps. These are companies valued at $1tn or more, and their performance has overshadowed other stocks, creating an extremely concentrated market — the most in the lifetime of any active US portfolio manager. There are 11 stocks today in the US that have a $1tn market capitalisation or larger. More may soon be coming with the initial public offerings of AI companies.
Risk management around the giga-caps has become paramount. Historically, active portfolio managers have thrived on sometimes contrarian bets to deliver alpha — the degree of market outperformance due to skill. However, the dominance of these companies creates an environment where a few investments can significantly impact portfolio performance.
This concentration demands a re-evaluation of traditional investment heuristics and requires portfolio managers benchmarked against the S&P 500 or another broad market index to own substantial positions for risk management.
The rise of junk stocks. While high-quality stocks have long been the go-to for conservative investors, the period since the Covid-19 pandemic has flipped this notion on its head. Lower-quality or “junk” stocks — assessed on factors such as free cash flow yield, dividend income and debt levels — have outperformed their more reputable counterparts. This shift reflects a market environment where risk-taking has been rewarded.
The median junk stock has seen its price-to-earnings valuation multiple expand since the pandemic. The median high-quality stock has had a series of cycles of multiple contraction. Why? It is partly the old market story that the maintenance of high quality isn’t rewarded, but improving from poor-to-average quality is. The trend has accelerated in recent years.
Earnings revisions are back in focus. The trend of tracking earnings revisions has seen a resurgence in importance. In the 1980s and 1990s, buying stocks that had just experienced an upwards earnings revision was a sound strategy. This practice subsequently waned in effectiveness and was sometimes considered backward-looking.
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However, there has been an increased trend of companies that succeed in beating earnings expectations continuing to do so in subsequent quarters. And investors seem to be recognising that more in recent years with such stocks outperforming.
The power of buybacks. In the past, stock buybacks were sometimes criticised as a poor use of capital. And many companies faced scrutiny for timing their buybacks poorly. However, since 2021, investors have been rewarding buybacks more.
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When companies engage in buybacks, they signal their belief in future growth, which can lead to a positive market reaction. The stock performance of companies engaging in buybacks has shown a marked improvement compared with those that do not.
Dividend increases matter more than ever. Another significant trend is the renewed focus on dividend-paying stocks. My firm looked at the performance of stocks relative to their industry group average following an announcement of a dividend increase. While this generally did not lead to outperformance from 1999 to 2010 and had a mixed impact from 2011-19, there has been a slow and steady outperformance in recent years for stocks increasing their dividends. This shift suggests investors may be valuing reliably improving income streams in uncertain times.
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Investors should consider integrating dividend growth, not just level, into their portfolio choices. Stocks with such growth offer not only stability but diversification given their low correlation to the AI theme dominating US equities.
Investing landscapes are always changing and past performance, of course, is no guarantee of future performance. But these themes should have staying power. Investors seeking equity investments beyond index-tracking should consider how they affect their portfolios.
