Distinguished client,
With the arrival of September, the always-surprising summer period, with its inevitable, recurring volatility, draws to a close. The summer of 2024 was no exception, as stock markets suffered a “mini crash” in early August, only to recover later in the month and throughout September. July’s market highs (see Graph 1) were unsurpassed, but only by the slimmest of margins.
EDM maintains that investor sentiment fluctuates between euphoria and gloom in unpredictable and surprising ways. So, post-summer, after the inevitable nerves have calmed, investors’ concerns are more or less the same as they were several months prior.
Based on recent conversations with clients, my aim in this letter is to address some of your concerns:
- Where is the economy headed? The decisions of the central banks
- Valuations: Are shares expensive?
- Long-term share prices depend on profit growth, but can current elevated rates persist?
- Public debt’s trajectory: Is it sustainable?
- The potential impact of the US election on 5 November 2024
Where is the economy headed? The decisions of the central banks
The summer of 2024 kicked off the long-awaited downward cycle of official interest rates, starting with the European Central Bank (ECB) and followed by the US Federal Reserve in mid-September.
The relevant question at this point is whether the lowering of rates is mere vindication for successfully reducing inflation or whether the aim is to prevent an apparent slowdown of the US economy from leading to a recession. Europe, for its part, is suffering from long-term economic stagnation (excluding Spain!)
Opinions are therefore divided on the issue, both in the US and elsewhere. With its recent measures, China is trying to emerge from a deflationary scenario caused by excessive real estate investment.
With regard to investment decisions, perhaps what is truly relevant is simply anticipating the fact that official rates (short term) will fall by almost 2% in the coming months. That is a considerable amount, already factored into the yield on public debt securities (see Graph 2). It should be remembered that yields fall as prices rise.
The importance of interest rates cannot be understated, because when rates fall, the price of ALL assets rises. This has a favourable impact on the valuations (P/E ratio) of shares and bonds. Stock markets and debt prices reflect this and, consequently, September closed in positive territory, despite the season’s historically questionable track record.
Valuations: Are shares expensive?
Interest rate cuts and their positive impact on share prices in the second half of September lead us inevitably to this question, but answering it requires some nuance.
Examining indices from the inside
At the September close, the S&P 500’s P/E ratio was 24.59x. That of the MSCI Europe was 14.6x. In fact, these multiples are not far removed from their historical averages if we discount the weight of the tech companies.
Graph 3 illustrates that the S&P 500’s multiples are heavily influenced by a very small group of companies (the Magnificent Seven) (*). By removing these from the equation, the P/E ratio of the index falls from 24.59x to 21.95x, which is more reasonable. It is worth remembering that the earnings growth (EPS) of this select group of tech companies exceeded 30% in Q2’24, doubling expected long-term growth.
Something similar occurs with the Granolas (*) in Europe, which brings us to the next point.
(*) Magnificent Seven: Nvidia, Microsoft, Meta, Tesla, Alphabet, Amazon, Apple.
Granolas: GSK, Roche, ASML, Nestlé, Novartis, Novo Nordisk, L’Oréal, LVMH, SAP, AstraZeneca, Sanofi.
Valuation risk is concentrated among big-cap companies, not small caps
While the shares of European companies (on the MSCI Europe) trade at a P/E ratio of 14.6x relative to NTM earnings, European (and Spanish) small-cap shares trade at roughly 10x (or less). While big caps trade at P/E ratios that are near the average for the last 10 years, small caps trade 30-40% lower!
The market, therefore, offers two different viewpoints. It is clear that valuation risk is concentrated in larger companies, rather than their small- and mid-sized counterparts.
Long-term share prices depend on profit growth, but can current elevated rates persist?
In the last 10 years, both the North American Magnificent Seven and the European Granolas have contributed massively to the results of our portfolios (see Graph 4). Naturally, this is attributable to very strong earnings growth. But will it persist? While nobody knows for sure, we expect the companies will continue growing, though in certain cases not as much as in recent years.
On this point, the impact of artificial intelligence is a pivotal issue, since the astronomical volume of Amazon, Microsoft, Google and Meta investments require high returns to justify them and, consequently, turn them into profits.
At the moment, the undisputed winner of these investments is Nvidia, which sells its chips at very high prices to a select few companies. Twenty years earlier, Apple did the opposite by selling millions of smartphones to countless of users.
This reflection serves to highlight the differences and similarities between the current AI boom and the previous internet boom. At the time, the positive impact of the internet initially benefitted fibre providers (CISCO), but later a group of non-tech companies capitalised on the new technology for their own benefit. That evolution could repeat itself.
The stock market has long anticipated the positive impact of AI and, therefore, it is advisable to act with caution. The managers at EDM Asset Management have reduced portfolio exposure to companies that have appreciated monumentally whose growth will be difficult to maintain.
Public debt’s trajectory: Is it sustainable?
This question has cropped up lately at our client meetings. Graph 5, which is self-explanatory, justifies concerns about the trajectory of debt volume vis-à-vis US GDP (Debt/GDP).
The debt has been fuelled by a long succession of annual deficits for which both Republican and Democratic administrations have been responsible. Currently, the deficit as a percentage of annual GDP (7%) is twice that of other developed countries.
One key advantage that the US has is its ability to borrow in USD, which may explain the apparent apathy toward initiating a budget adjustment that seems inevitable in the long term. The country does not lack the resources, but perhaps the political will to do so. As long as economic growth remains high, these are conceptual concerns that will hardly translate into panic on the debt market.
The same is true for other countries: the new government in France will face a severe fiscal adjustment—always unpopular—(see Graph 6) because, as a country with high taxes, spending on social protections far exceeds the EU average.
Are there signs of concern about this? Perhaps the 2024 uptick in gold prices (see Graph 7) is not only related to a policy of prudent diversification for the various central bank reserves, but also to a certain degree of caution in light of this issue.
The potential impact of the US election on 5 November 2024
This letter is the last I will send before the US presidential elections. Given the radicalisation and polarisation of the US electorate and the parity in the polls, prudence is in order. Section 4 above demonstrated that in some respects the policies of the two major parties are not so divergent. We believe this is the case now, even if their arguments differ.
For us Europeans and, especially for our major companies, the imposition of 10-20% tariffs on imports is not welcome news. Protectionism is deeply-rooted in American politics and it appears to be making a comeback. The most important question is whether the abandonment of international trade rules, which have delivered phenomenal growth to the global economy, will be replaced by a type of fragmentation that would adversely affect many countries around the world.
For others, the Democrats’ growing spirit of interventionism is a welcome departure from the free-market framework preferred by many voters, and is justified by the high cost of certain basic products and services.
Regardless, it appears unlikely that either candidate will tackle the issue of the deficit, since it rides on the back of the colossal spending and subsidy programme launched by President Biden and Donald Trump’s tax cuts. If he regains the presidency, Trump has pledged to repeal the Inflation Reduction Act, though it is common knowledge that candidates tend to amend their promises after victory (see Graph 8).
What are we doing with our portfolios?
Given the current political and economic uncertainty, our portfolio management decisions are based on three factors:
- The core economic scenario for the US is a soft landing, but a less favourable development—ie: a recession, albeit a mild one—cannot be ruled out.
- Consequently, for several months now, while maintaining our approach based on the analysis of company fundamentals, we have begun to diversify our portfolios to have well-remunerated, short-term cash or bonds available in order to capitalise on opportunities as they arise.
- "The world will not end". Uncertainty has always existed and still the best companies continue to grow successfully. Our aim, therefore, is to remove emotion from the equation, select quality companies, trust the data, and stick to a long-term (non-speculative) vision.
Your trust is greatly appreciated.
Yours sincerely,
Carlos Llamas
CEO
APPENDIX. EDM fund yields YTD
LEGAL CONSIDERATIONS
1) This information is for advertising and information purposes only. It is not and cannot be considered investment advice or a legal opinion, is not intended to replace necessary investment advice and does not constitute an offer to sell or a request to buy.
2) All opinions and estimates provided are based on sources believed to be reliable. However, EDM Gestión, S.A., SGIIC cannot guarantee that these sources are accurate or complete, and assumes no liability whatsoever for any direct or indirect loss that may result from the use of the information provided in this document.
3) This information includes data referring to past performance of the products mentioned above. EDM Gestión, S.A., SGIIC warns that past performance is not a reliable indicator of future performance.
4) Investors should be aware that the products included in this document may not be suitable for their specific investment objectives, financial or equity position, or risk profile. Investors should therefore make their own decisions taking into account these circumstances and seek specialised tax, legal, financial, regulatory, accounting or other advice as necessary.
5) It is stated for the record that the instruments included in this information may be affected by various common causes such as:
- Market disruptions due to unforeseeable circumstances.
- Liquidity risks and other risks that alter the performance of the investment.
6) This documentation may include data based on currencies other than those used by the recipients of the documentation. Therefore, the possibility of any upward or downward change in the value of the currency and its impact on the results of the proposed products or instruments must be considered.
7) For each of the EDM Gestión, S.A., SGIIC Funds, a full prospectus, a key investor information document, periodic reports and the latest audited financial statements are available to the public and can be requested free of charge at the registered office of the Management Company or on the website www.edm.es.
8) EDM Gestión, S.A. SGIIC is a public company incorporated under Spanish law, registered in the Collective Investment Undertaking Management Companies Register of the Spanish National Securities Market Commission (CNMV) under number 49 and registered with the Commercial Registry of Madrid in volume 36,739, page 52, sheet M-658.326, with tax identification number A-58.217.175. It engages in the representation, management and administration of investment funds and investment firms domiciled in Spain and under Spanish law, and discretionary investment management.
DISCLAIMER
EDM Ahorro FI is an authorised investment fund regulated by the CNMV (registration no. 47) and managed by EDM Gestión, S.A., S.G.I.I.C. (CNMV registration no. 49). It is a fund with a risk profile of 2 on a scale of 1 to 7. Over the last five years, Class L obtained the following annual returns: 2019: 4.78%; 2020: 0.38%; 2021: 1.58%; 2022: -4.08%; 2023: 5.34%.
EDM Renta FI is an authorised investment fund regulated by the CNMV (registration no. 530) and managed by EDM Gestión, S.A., S.G.I.I.C. (CNMV registration no. 49). It is a fund with a risk profile of 1 on a scale of 1 to 7. Over the last five years, Class L obtained the following annual returns: 2019: 0.61%; 2020: -0.3%; 2021: -0.11%; 2022: 0.07%; 2023: 3.20%.
EDM Credit Portfolio Fund is a sub-fund of EDM International SICAV authorised in Luxembourg and regulated by the Commission de Surveillance du Secteur Financier (CSSF) (registration no. 851). The Management Company is Waystone Management Company (Lux), S.A., which is subject to oversight by CSSF. The sub-fund is managed and marketed in Spain by EDM Gestión, S.A., S.G.I.I.C. (CNMV registration no. 49). This is a sub-fund under Article 8 of the SFDR. It is a fund with a risk profile of 3 on a scale of 1 to 7. Since the inception of Class L on 19/01/2021 and until 31/12/2023, it obtained the following annual returns: 2022: -14.66%; 2023: 8.85%.
EDM Cartera FI is an authorised investment fund regulated by the CNMV (registration no. 4043) and managed by EDM Gestión, S.A., S.G.I.I.C. (CNMV registration no. 49). It is a fund with a risk profile of 3 on a scale of 1 to 7. Over the last five years, Class L obtained the following annual returns: 2019: 16.12%; 2020: 3.87%; 2021: 12.98%; 2022: -16.28%; 2023: 17.51%.
EDM Inversión/Spanish Equity Fund is a sub-fund of EDM International SICAV authorised in Luxembourg and regulated by the CSSF (registration no. 851). The Management Company is Waystone Management Company (Lux), S.A., which is subject to oversight by CSSF. The sub-fund is managed and marketed in Spain by EDM Gestión, S.A., S.G.I.I.C. (CNMV registration no. 49). This is a sub-fund under Article 8 of the SFDR. It is a fund with a risk profile of 5 on a scale of 1 to 7. Over the last five years, Class L obtained the following annual returns: 2019: 12.36%; 2020: -10.18%; 2021: 14.52%; 2022: -12.69%; 2023: 17.28%.
EDM Strategy Fund is a sub-fund of EDM International SICAV authorised in Luxembourg and regulated by the CSSF (registration no. 851). The Management Company is Waystone Management Company (Lux), S.A., which is subject to oversight by CSSF. The sub-fund is managed and marketed in Spain by EDM Gestión, S.A., S.G.I.I.C. (CNMV registration no. 49). This is a sub-fund under Article 8 of the SFDR. It is a fund with a risk profile of 4 on a scale of 1 to 7. Over the last five years, Class L obtained the following annual returns: 2019: 30.42%; 2020: 0.28%; 2021: 29.23%; 2022: -17.81%; 2023: 26.01%.
EDM Global Equity Impact Fund is a sub-fund of EDM International SICAV authorised in Luxembourg and regulated by the CSSF (registration no. 851). The Management Company is Waystone Management Company (Lux), S.A., which is subject to oversight by CSSF. The sub-fund is managed and marketed in Spain by EDM Gestión, S.A., S.G.I.I.C. (CNMV registration no. 49). This is a sub-fund under Article 8 of the SFDR. It is a fund with a risk profile of 4 on a scale of 1 to 7. Since its launch on 30/05/2022 and until 31/12/2023, Class L obtained the following annual returns: 2023: 21.24%.
EDM American Growth Fund is a sub-fund of EDM International SICAV authorised in Luxembourg and regulated by the CSSF (registration no. 851). The Management Company is Waystone Management Company (Lux), S.A., which is subject to oversight by CSSF. The sub-fund is managed and marketed in Spain by EDM Gestión, S.A., S.G.I.I.C. (CNMV registration no. 49). This is a sub-fund under Article 8 of the SFDR. It is a fund with a risk profile of 5 on a scale of 1 to 7. Since the inception of Class L on 18/01/2021 and until 31/12/2023, it obtained the following annual returns: 2022: -43.38%; 2023: 34.92%.
EDM Latin American Equity Fund is a sub-fund of EDM International SICAV authorised in Luxembourg and regulated by the CSSF (registration no. 851). The Management Company is Waystone Management Company (Lux), S.A., which is subject to oversight by CSSF. The sub-fund is managed and marketed in Spain by EDM Gestión, S.A., S.G.I.I.C. (CNMV registration no. 49). This is a sub-fund under Article 8 of the SFDR. It is a fund with a risk profile of 5 on a scale of 1 to 7. Over the last five years, Class L obtained the following annual returns: 2019: 22.32%; 2020: -28.51%; 2021: -19.03%; 2022: 11.17%; 2023: 24.91%.
EDM International Equities FI is an authorised investment fund regulated by the CNMV (registration no. 2817) and managed by EDM Gestión, S.A., S.G.I.I.C. (CNMV registration no. 49). It is a fund with a risk profile of 4 on a scale of 1 to 7. Over the last five years, Class L obtained the following annual returns: 2019: 6.68%; 2020: 1.95%; 2021: 5.07%; 2022: -14.98%; 2023: 24.40%. There were significant changes in policy in 2022. The data prior to 2022 are not representative under the current investment policy.
EDM Pointer SA SIL is an authorised hedge fund regulated by the CNMV (registration no. 26) and managed by EDM Gestión, S.A., S.G.I.I.C. (CNMV registration no. 49). It is a fund with a risk profile of 4 on a scale of 1 to 7. Since its launch on 26/11/2021 and until 31/12/2023, Class A obtained the following annual returns: 2022: -7.96% and 2023: 13.16%.
Fondomutua Pensions UNO, FP is an authorised pension fund regulated by the Directorate General of Insurance and Pension Funds (DGSFP) (registration no. F2154). Mutuactivos Pensiones, S.A.U., S.G.F.P. (DGSFP registration no. G0135) is the Fund Manager and EDM Gestión, S.A., SGIIC (CNMV registration no. 49) is the Delegated Manager and Promoter. It is a fund with a risk profile of 2 on a scale of 1 to 7. Over the last five years, it obtained the following annual returns: 2019: 3.79%; 2020: -0.67%; 2021: 1.57%; 2022: -8.16%; 2023: 4.44%.
Fondomutua Pensions DOS, FP is an authorised pension fund regulated by the Directorate General of Insurance and Pension Funds (DGSFP) (registration no. F2155). Mutuactivos Pensiones, S.A.U., S.G.F.P. (DGSFP registration no. G0135) is the Fund Manager and EDM Gestión, S.A., SGIIC (CNMV registration no. 49) is the Delegated Manager and Promoter. It is a fund with a risk profile of 4 on a scale of 1 to 7. Over the last five years, it obtained the following annual returns: 2019: 23.67%; 2020: 5.66%; 2021: 22.05%; 2022: -20.56%; 2023: 29.98%.
