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Why We’re Sticking to Quality and Diversification
July 5, 2024
Jim Madden, CFA, Tony Tursich, CFA, and Beth Williamson
Summary Points:
- We’ve seen the equity market narrow once again, led by a handful of high-momentum technology stocks in the AI space.
- Rallies in momentum stocks have often reversed dramatically, exposing investors to significant pain.
- Our time-tested approach continues to focus on long-term returns and downside risk management, leading us to stick to a well-diversified, quality-oriented positioning.
- The fund continues to emphasize attractively valued companies across sectors that are creating shareholder value through innovation and by managing both financial and non-financial risks.
Momentum investing, a strategy of chasing what’s hot and selling what’s not, has been a winning strategy for the past 12 months and certainly year-to-date. Momentum’s outperformance since the artificial intelligence hysteria took hold has been astonishing. The chart compares the performance of high-momentum stocks to the broader equity market and to quality stocks and highlights the magnitude of the current rally.
US Large-Cap Stocks: Momentum Versus Quality
Past performance is no guarantee of future results. Source: Bloomberg.
It’s rare for momentum rallies to persist for a long time, and when they reverse, the downturns can be dramatic. Consider the period from the peak of the dot-com bubble in March of 2000 through the end of 2001. Momentum underperformed the broader market significantly, while quality held up quite well. The S&P 500 Quality Index was up 20%, while the S&P 500 Momentum Index was down more than 40%. We may not like these markets, but we are sticking to our quality discipline because we are confident that fundamentals will ultimately prevail.
Case Study of a Momentum Rally Collapse: Dot-com Implosion
Past performance is no guarantee of future results. Source: Bloomberg.
Concentration Risk Versus Diversification Opportunity
Concentrated investing has also been a winning strategy in 2024. Large-cap stocks have been the clear leader during the current bull market. The top decile of the 50 largest stocks in the S&P 500 Index was the only subsector to have outperformed the broader S&P 500 this year. In fact, five stocks accounted for 60% of the aggregate S&P 500 Index’s year-to-date return. From a market cap standpoint, these five stocks have collectively surged by 35% and now comprise 25% of the S&P 500 Index’s equity capitalization.
Just 10 Companies Comprise More than a Third of the S&P 500’s Overall Market Cap
Recessions are indicated by shaded areas. Past performance is no guarantee of future results. Source: Bloomberg, Apollo Chief Economist.
We don’t believe this narrow leadership will last. In the second half of the year, we expect big tech’s profit growth to slow, opening the door to broader market leadership. Meanwhile, sectors like materials and health care are positioned for significant profit growth in the fourth quarter after contracting in the first.
Decades of experience support our conviction in the value of diversification. Diversification seeks to mitigate unsystematic risk and can lead to better opportunities and more consistent, higher risk-adjusted returns. Accordingly, we have positioned the fund to participate not only in technology growth (including in the AI ecosystem) but also in a breadth of innovation, including more idiosyncratic opportunities. Looking forward, we believe the fund is well positioned to benefit from better relative performance of other economic sectors.
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Diversification and asset allocation do not guarantee a profit or protect against a loss. Alternative strategies entail added risks and may not be appropriate for all investors. Indexes are unmanaged, not available for direct investment and do not include fees and expenses.
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