Owning something different finally paid off

WEBVTT
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Welcome to the InvestSense market commentary for the third week
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of October 2026. And it was a week where Australia
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actually outperformed the rest of the market, actually up by
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a percent or so while, and this chart shows the
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last two weeks, but you can see it's mostly in
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the last week we've seen this acceleration of pessimism, especially
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around the AI trade. And you can see the Nasdaq
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down by 6% over the last week or so and
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emerging markets as well driven obviously by Korea and the
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big chip manufacturers there. Interestingly, though, the S & P
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500 was actually flat. And as I said, more defensive
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economies or ones with more defensive exposures like the UK,
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but also Australia, actually up by a little bit. And
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we'll talk a little bit more about where this defensiveness
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is showing up in some somewhat unlikely areas later on.
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But one of the things that might be boring the
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local market is interest rate expectations have ebbed a little bit.
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There's now only one hike expected by markets for the
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rest of the year. And in that sense, bad news
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on the unemployment side, although it only ticked up a
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little bit. But maybe it was enough to say that
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there's some heat coming out of those inflation numbers. Now,
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the other big news last week was the flop of
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the firm's floatation rate. And it looks like they're going
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to try again in the US. But that that was
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pretty much the lightning rod for fears around the world
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that it's going to be difficult for a lot of
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these hyperscalers to monetize AI in time to pay for
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the compute that they need. So there's an awkward tradeoff
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going there. And interestingly, the price of chips actually continues
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to rise unabated. but it's the valuation that people are
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putting on that, the longevity of this cycle, that's maybe
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got investors questioning things a little bit, but also it's
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become a credit problem. And that's one of the things
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that we talk about in this week's conversation with Andrew,
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because a lot of these hyperscalers, but also the companies
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that they've engaged are raising.
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A lot of debt.
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A lot of that sits off a balance sheet and
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people are doing their sums and just wondering how this ends.
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So you're seeing credit spreads, and protection on default, so-called
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CDS credit default swaps, rise quite substantially, but especially for
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those high risk, high yield data center driven deals. And Australia,
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as I said, the market actually held up pretty well.
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Some of it was because health care utilities, for example,
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and staples are somewhat defensive, but also the banks did
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pretty well. And it was only materials that were off
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a little bit. Now, the other area of focus for
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a which is deemed to be particularly significant. It always
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is for different reasons. But we're particularly interested in this
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one because if consensus is to believe this earnings story,
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this earnings momentum in corporate America seems to be broadening out.
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But also, again, you have to dig underneath and this
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what this chart shows. is 29% expected growth. So these
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are really strong numbers and they have been delivering the
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last few quarters, but they're expected to come from a
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wider cohort of stocks.
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However, when you unpick that, there's still a bit.
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Of narrowness about it. And especially on the right-hand side,
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we've got the MAG7, again, a whopping 33%. But if
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you take just two stocks out of those, that takes
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you down to 7.5%, which tells you that the other hyperscalers,
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which are not the chip manufacturers, and also Mesa, which
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is coming off a low base. Nvidia is the other
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Mag 7 one with the chip exposure. The others, they're
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kind of, because they're spending so much money on these chips,
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and that's their main focus at the moment, earnings are
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actually coming off a little bit. Now, this is a
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chart that we've been showing, that we talked about last week,
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and that we've been taking around the traps.
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I'll just summarize it very briefly.
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It's basically saying, talking to this Goldman Sachs S &
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P 500 XAI index, which shows this surprising relationship especially
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if you look over the last few weeks and what
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this line shows is basically complete diversification, if you like.
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You've seen this XAI composite index up by about six
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or seven percent in the last five or six days
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when the AI trade has actually done exactly the opposite.
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And when you look at valuation, which.
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Is the bottom panel of this channel, the price earnings ratio,
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you're paying a lot less for that. And if you
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look at the middle one, and this is what's key
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about this earnings season, is you're seeing the growth that's
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coming through with these so-called XAI stocks.
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You know, that's healthcare, utilities, industrials.
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And that's about 55% of the index by Goldman Sachs
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reckoning in terms of chips, hyperscalers. cloud companies, that's about
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45% of the S & P 500. But you can
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see in this middle panel that you're actually getting the
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same amount of growth for a much lower valuation. Now,
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this reflects something that we've seen around the world in
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different areas. And it's just kind of interesting, as we
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sort of often have said recently, when we've seen a
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little bit of this rotation trade happen, one swallow a
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summer doesn't make. However, we've got a couple of global
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small caps that we follow closely. the global small cap
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index was down only by a percent or so. So
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the asset class was reasonably resilient. But these so-called quality
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growth managers that got hammered earlier in the year actually
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seen quite a rebound. And maybe because even though it's
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difficult to ascertain exactly why, because sometimes these can be
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high multiple companies, they don't look cheap, but they're seen
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as compounders, high quality businesses. And during all that volatility
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that we saw in the last couple of weeks, actually
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up by 3%.
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Or 4%, which is kind of interesting.
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And over the quarter, you've seen this range-bound volatile nature
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of the underlying market or the benchmarks, if you like,
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and some really quite strong returns from some of these
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small cap managers. Exactly the same relationship in emerging markets,
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very different companies. And we've got a couple of emerging
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market managers that don't have any exposure to the chip
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even though they did in the past they rolled out
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of that and they're actually up now this is the
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thing that's really difficult to model they're not necessarily up
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because the fundamentals for the stocks that they improved that
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they invest in have improved they're up because there's a
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substitution effect investors look around and say well I've got
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too much of this other stuff that's related to chips
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what else would I invest in that's roughly the same
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and then you get this this uptick in performance Now
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what we're hoping, it seems a little bit twee and
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historical analogues are always a bit dodgy, but what we're
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hoping is that this is a little bit like after
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the dot-com boom. We're not saying this is the dot-com boom,
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but you did have a similar instance of a rotation
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into stuff which had been unloved. And even though you
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had a recession, a lot of these supposedly cyclical smaller
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companies actually rose progressively over the next few years because
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they started off relatively cheap and the market looked through
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that recession. So this is why we sort of wonder
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whether this might be a similar instance where maybe just
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marching to a different tune might give you even more
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diversification benefit than you originally expected. One last thing, just
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to sort of point out what's been happening in markets.
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Local diversified portfolios have actually done better than you might expect.
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And one of the things has been the weakness of
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the Aussie dollar. Still in that sort of range between
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69 cents and 73 cents. It sort of came down
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towards 69 cents more recently. Now, there is a silver
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lining for investors. We have increasing as a peer group
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in Australia. We have increasing amount invested in international equities.
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So that does give you a little bit of a buffer.
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But the interesting thing is the Aussie dollar is just
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starting to react in a slightly cyclical way, maybe related
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to demand for our materials. or what traders are thinking
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about the local currency. But it's starting to add a
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little bit of that defensiveness, which was looking a little
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bit noisy and less reliable earlier in the year. So
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the last point, just going to finish on, which is
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related to all of this, we've been discussing at our
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internal investment committee before we go out to our clients
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and talk about these issues, about what diversification really means.
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And what this chart shows is our asset allocation over
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time You won't be able to sort of follow all
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the little squiggles there. But the main narrative is that
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when we came into pre-COVID, we didn't forecast any particular
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upset then, obviously. But we came into that relatively defensive
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on a growth defensive basis because equities looked expensive and
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bonds didn't really. A few years later, it was really
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within the asset class that you saw those diversification benefits.
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It was how much US you had compared to the
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rest of the world because the US looked really expensive.
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and within bonds it was duration versus credit. Now we
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think it's an even more nuanced picture and you have
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to really look under the bonnet and maybe those, unless
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you want to take an overt growth defensive position which
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is fraught with difficulty and timing obviously, that maybe you
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have to look underneath the bonnet, you have to look
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at the sort of more nuanced concepts that we talked
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about before and we're hoping that that's where some of.
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The diversification comes.
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However, We also have to look out the front window
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and conversations like the one that we have in the
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What We're Working On video with Andrew Hunt this week,
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maybe give us a little bit of an indication about
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when we might actually want to sort of use that
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growth defensive lever. And spoiler alert, the overall takeaway from
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that is there's no real need yet to run from
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the hills.
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But what Andrew does.
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Talk about, you should a really interesting bit of research,
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which talked about not just the balance sheet side of
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the debt to GDP conundrum that everyone's watching at the moment,
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and especially with, you know, riots in France because of
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lack of spending, but markets acting up because there's too
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much spending. This is a difficult equation for all Western
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governments to weigh up. But it's the cash flow implications.
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And he did a little bit of a study on
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what happens, what actually causes or what is the catalyst.
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For an upset in bond markets.
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And he thinks that in France, it's much more the
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behavior of the dominant lender at the time, which in
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this era is foreign investors.
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The U.S.
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In particular relies on capital inflows mainly from Asia, mainly
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from those exporting nations and where they recycle their surpluses.
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And he thinks that's the thing to watch. So in
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terms of that sort of growth defensive split, are we
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calling a recession? All those things that people tend to
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be really interested in. That's one market that we're looking
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at in conjunction with Andrew. And it's basically steady as
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she goes for the moment. But he thinks that that
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could be a source of volatility and something well worth watching,
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in particularly the strength of Asian currencies, including the renminbi.
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Which has been steadily getting stronger and stronger. It's obviously
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a managed currency.
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And in that sense, there's also, you know, maybe a
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reason for hope there because that is a managed thing.
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And he thinks it could be part of an adjustment
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and this rotation could continue in a measured way, which
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would be great for portfolios to have that rotation without
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an imminent downswing. Anyway, here's to hoping next week we'll
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probably have a little bit more from the U.S. earnings
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season to talk about and and also some work we're
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doing on different scenarios.
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Look forward to talking then. Thank you.