Marcellus’ Global Compounders Portfolio (GCP) strategically invests in 25-30 deeply moated global companies aligned with megatrends, fostering a consistent mid to high teens compounding of free cash flow/earnings.

In this newsletter, we present our perspective on valuations in the US market given that we do see signs of excess in S&P 500 valuations. However, these concerns are driven by select pockets of punchy valuations in the S&P 500; valuations in the broader American market remains reasonable – particularly among midcaps. In the Global Compounders Portfolio, we remain mindful of valuations and have addressed these concerns by positioning the vast majority of the portfolio outside the megacap US stocks.

Permissible Accredited Investors* can now invests in GCP Strategy with minimum ticket size USD 25,000.

*Accredited Investors shall qualify eligible criteria as defined under IFSCA-IF-10PR/1/2023-Capital Markets dated January 25, 2024. 

For non-accredited investors, Investment in Marcellus’ GCP is through Separately Managed Accounts (i.e., SMAs, just like a PMS) via GIFT City (regulated by IFSCA) with a minimum investment amount of USD 150,000.

Latest regulatory changes pertaining to Global Investment:

  • For Resident Indian investors, Long Term Capital Gains (LTCG) on global equities now reduced to 12.5% (without indexation benefit) in recent budget Vs 20% (with indexation benefit) earlier
  • Salaried personnel investing in GCP can now set off the TCS paid (at the time of LRS transaction) against TDS to be deducted on salaries
  • Resident Indians can now open a ‘Foreign Currency Account (FCA)’ in IFSC and can use the funds for any current or capital account transactions in other foreign jurisdictions (outside IFSCs)
  • IFSCA issued consultation paper on 5th August 2024 which proposed to reduce minimum investment amount in GIFT PMS to be USD 75,000.

These recent changes, which simplify and align long-term capital gains tax with domestic equities and allow resident Indians to open foreign bank accounts in GIFT City, significantly reduce friction.

The Narrative: US markets are expensive

The US market has seen a strong rally in 2024 with the S&P 500 up 32% over the past year. This has been driven in large part by the tech sector (expected to benefit from the ongoing AI wave) with an element of optimism around a broader economic recovery adding to the gains over the past month. Both these factors are somewhat unique to the US without parallels in other developed markets.

This phase of relative outperformance has sparked concerns around valuations of the US market – especially with regards to two aspects:

1. Outperformance relative to Europe: This shows up in returns across time periods from 1 year to 20 years. However, this outperformance is particularly stark on a 1-year basis

2. High valuations for the S&P500 relative to its own history with current multiples close to levels last seen during the internet boom of the late 1990s

The Reality: Earnings have been just as strong as price returns

The narrative around relative performance of the US market anchors heavily to price and ignores earnings. While the US’ consistent outperformance on returns is often commented on, the fact that US earnings growth has just as consistently outperformed that of Europe goes relatively unnoticed. We have commented on some of the unique factors that drive such corporate dynamism in the US earlier (The Four Pillars of American Capitalism) . It’s because of this gap in earnings that we tend not to fret about outperformance against Europe. While occasional and episodic European outperformance can’t be ruled out, we don’t see a case for European performance steadily keeping pace with the US.  

The ‘But’: Pockets of excesses do exist in US markets

That being said, the second concern around headline valuations in the S&P 500 is something we do share. However, this discussion merits a more granular look – especially with regards to how the S&P 500 compares to the broader market (as represented by the mid-cap S&P 400 index). Two key notables from this exercise are:

  • Valuations for the S&P 400 have not seen the same increase that the S&P 500 has. This reflects the relatively narrow nature of the rally in 2023 and 2024. As the charts below show, S&P 400 valuations remain in the historic band with the discount of the S&P 400 relative to the S&P 500 in fact at a multi decade high

  •  Earnings growth in the S&P 400 over the long term has been slightly better than the S&P 500 – reflecting better growth among smaller companies. However, it does show more volatility. This reflects greater macro sensitivity – something which is reflected in the relatively weak earnings performance over the past three years. As the broader macro environment in the US improves, the earnings gap against the large cap index should normalize.

This gap in earnings growth in recent years has led to the mid-cap S&P 400 index underperforming relative to the large-cap S&P 500. As the earnings performance normalizes, this gap in price performance may also normalize.

How are we guarding GCP against pockets of market excess?

For our Global Compounders portfolio, we have access to multiple tools to guard against valuations concerns.

·    Firstly, we have flexibility around the market capitalisation of stocks we own. As a result, the representation of megacap stocks is low in our portfolio.

·    Second, we are not restricted to the US market and can own high quality companies elsewhere. For example, one of our core holdings – Hermes, is listed in France. Overall, around 12.7% of the portfolio consists of stocks listed outside the US.

Our mindfulness around valuations also reflects in some of the portfolio decisions we have made. In 2024, we sold down our holdings in Costco and Apple. These are both franchises we greatly admire. However, the valuation for the names going outside our comfort zone caused us to sell our holdings.

Regards,
Team Marcellus

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