January 13, 2025

Where, How, What, Why and Where again?

At the start of the new year, it’s a good idea to ‘take stock’ and actively place recent conditions in the economy and markets in context of history. A good starting point is to ask the following –

• Where do things stand today?
• How did we get here?
• What outlook might investors hold for economies, markets, sectors, ?
• Why might we see a continuation in or a change in these conditions?
• Where might we see changes (positive and negative) that may surprise in the years ahead?

Invention of new tools and ways of doing things have been the key drivers of productivity growth and real GDP growth for centuries. Collectively these enable our species to work smarter not harder and productivity gains. A.I. is the latest tool in the toolbox and its ability to enhance productivity (enhance real GDP growth) here and abroad and across most sectors of the economy may be the greatest contributor we have seen so far. It along with other productivity gains have propelled the U.S. economy to a greater degree than other nations. In turn, our share of global profits and market value is the envy of the world. It has benefited our stock market to an incredible degree. The U.S. constitutes roughly 5% of global population, 25% of global GDP and the lion's share of global stock market value.ⁱ The charts below show the sector and country weights of the MSCI ACWI (all country world index) IMI (total investible index – e.g., large, mid and small caps) as of November 29, 2024 -

Source: MSCI.com

As you can see in the chart on the right, the U.S. constitutes nearly 2/3rds of global market value. The technology and financial Sectors are the largest sectors. The sector allocations are very different for the MSCI USA and the All Country Excluding the U.S. indexes. The U.S. sector weights are on the of top next page followed by the rest of the world’s country and sector allocations.

Source: MSCI.com

Source: MSCI.com

As you can see, the tech sector constitutes 29.3% and the related communications an addition 8.3% (e.g., 37.6%). The financial sector is just 14.2%.

As the charts above show, outside the U.S., the financial sector is the largest at 22%, while technology plus communications combined are just 18.4%. I also note that the chart at the bottom of page 1 shows that Japan’s share of global stock market value is just 5.3%. At its peak in 1989, Japan constituted the largest in the world’s market cap at 40% while the U.S. was about 33% of global market value at that time. Wow how things can change and how different are the sector weightings are in the U.S. versus elsewhere.

Over time, sector weightings in the U.S. and elsewhere wax and wane. Below is a summary of several U.S. sector weights on March 31, 2012 compared to November 29, 2024.

U.S. sector allocations 3/31/2012 vs. 10/29/24

Source: MSCI.com

Obviously, sectors in and out of the U.S. fluctuate in value over time. Those that increase tend to have good EPS growth with a PE expansion and vice versa.

An important question with no clear answer is what lies ahead? We wish we knew, but an observation we make is that investors are well served to try to identify and allocate money into market segments that are out of favor and attractively priced and refrain from chasing performance and buying into market segments that have been particularly pleasing to own. Leadership changes are common over time. A focus on valuation can help investors find opportunities before they experience strong moves upward and resist the temptation to invest heavily in segments that have appreciated the most over periods of 5 plus years.

Since 1989, the U.S. share of global capitalization has essentially doubled from 33% to 66%, while Japan has gone from 40% to 7%. Might the U.S. share go higher? That is certainly possible – particularly if growth in earnings remains strong and investors allocate even more into this market segment. That said, the rest of the world constitutes 95% of global population, 75% of global GDP and only 1/3 of global market value. Meanwhile many of the other large economies, the U.K. Germany, Japan, China have market caps that are tiny fractions of ours because many have are selling at low valuations (relative to ours and their own historical metrics). They strike us as demonstrably out-of-favor much like the U.S. tech sector was as recently as 2012. We believe that collectively the rest of the world will likely grow in terms of aggregate share of global stock market value.

Speaking of the tech sector, U.S. technology companies have in aggregate delivered on the innovation and profitability front. They have also driven the lion’s share of U.S. market and global returns in recent years. We believe advancements in A.I. (artificial intelligence) will likely lead to improvements in productivity across large swaths of the U.S. and global economy for decades to come in healthcare, robotics, logistics, agriculture, manufacturing, housing, energy procurement and development and scores of other segments of the economy. In other words, the benefits will likely enhance efficiency and output far beyond the leading technology companies at the forefront of this new, potentially game changing technology. These benefits will likely pave the way for future and more broad-based productivity gains both here and abroad. This could help foster enhanced revenue and earning growth globally and in turn enable valuations to also increase across broad segments of the economy. We certainly hope so.

“The essence of effective investment management lies is in risk management, rather than the management of returns.”- Benjamin Graham

In summary, we believe broad allocation of capital in the equity portion of portfolios both within and outside the U.S. markets is important from a diversification standpoint. That’s because various market segments including ‘growth’ and ‘value’ as well as large, mid and small caps have historically performed differently over time. We believe we are likely to continue to experience leadership changes across major equity market segments over the years and decades to come. Therefore, holding broad allocations across major market segments is necessary to help ensure investors have meaningful ownership of whatever segments perform best and to also ensure that they are never excessively concentrated in segments that perform abysmally (as they all tend to do) over any multi-year or decades long time periods. Getting the best of returns in the best of times is nice, but not as important as avoiding the largest declines in the worst environments. A diversified approach like the one we adhere to strategically helps ensure a smoother ride. That is particularly true for investors who rely on their investments to support their lifestyles in retirement. We also believe it makes inherent sense for investors who are able to add to their investment portfolios over time.

We are committed to your financial well-being. As always, we welcome your questions and comments. We also wish to reiterate our gratitude for entrusting us to manage your investment portfolios.

W. Richard Jones, CFA
Partner, Harmony Wealth Partners

ⁱThe MSCI uses another method to value country and sector allocations using the following methodology based upon fundamental factors instead of market capitalization. Using this method the allocation weights on November 29, 2024 are as follows –

Source: MSCI.com

As the charts above show, using fundamental factors, the weight in the U.S. is not over 65%, but 46.5%. Other countries all have larger allocations based upon things like sales, book value and earnings than is the case when the weights are determined by market value. Please note in the left side that allocations to high current market valuation, like technology are lower than is the case with market value weighted methodology. Prospective returns based upon these methods that de-emphasize high valuation segments could yield better results in a potentially mean reverting world. At the margin, our allocation method is directionally closer to the fundamental methodology than current market value.

Any opinions are those of Richard Jones and not necessarily those of Raymond James. Expressions of opinion are as of this date and are subject to change without notice. There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct. The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete, it is not a statement of all available data necessary for making an investment decision, and it does not constitute a recommendation. Past performance is not a guarantee of future results. Investing involves risk and you may incur a profit or loss regardless of strategy selected, including asset allocation and diversification. The indexes mentioned are unmanaged and cannot be invested into directly. Keep in mind that index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor's results will vary. This information is not intended as a solicitation or an offer to buy or sell any security referred to herein. Investments mentioned may not be suitable for all investors.

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