During the third quarter, the strategy outperformed the MSCI Emerging Markets index by 3.1% even as the index rose by over 10% in US$ terms.
The largest contributions came from China, driven by stock selection, our underweight position in India as well as exposure to precious metals. This was offset somewhat by stock selection in Taiwan and weaker performance in the UAE and Latin America.
Markets were driven primarily by increasing excitement over the growth of Artificial Intelligence coupled with strong demand for gold and increasingly other perceived safe haven metals. Every one of the fifteen top contributing stocks to index performance was either a play on AI or a mining company. Collectively they accounted for two thirds of index performance.
During the quarter we have taken the opportunity of weakness to add to markets where we have been highly underweight in recent years, such as India and Saudi Arabia. While valuations remain relatively elevated, they have come declined on both an absolute and relative basis. We have been funding this by taking profits in some of our strongest performing markets such as the UAE and Poland. We have also been active in switching between positions in Korea where we have seen some very significant moves in recent months.
While a powerful tailwind from technology stocks is a regular feature, we struggle to remember the last time gold stocks were such a major contributor to a bull market. The rally in gold, silver and increasingly other metals likely reflects the real and perceived weakness of the US dollar as well as some unease about the market euphoria elsewhere.
There is little need to add to the handwringing over a potential AI bubble – the technology is simultaneously exhilarating and a black hole for sucking in capital with uncertain returns. As long as both optimists and pessimists continue to see mounting evidence to support their views, valuations broadly reflect near term earnings – after all it takes two to make a market! We can still invest in AI growth stocks with strong balance sheets on single digit P/E multiples but mindful that these earnings are predicated on further expansion of AI investment. Opportunities also arise in non-AI technology like traditional memory, as AI capex displaces capacity additions and makes for tighter markets while valuations remain cheap.
Balancing out technology related themes, we have also been holding onto our growing exposure to gold and silver equities so far although there will be inevitably be a point where the parabolic rise of the metals needs to pause. While the drivers are clear and well understood, there is no coherent valuation mechanism for them as demand is largely driven by sentiment rather than consumption even as supply is constrained.
Inevitably, with market participants so focused on a narrow set of themes, there is a rising opportunity set to buy formerly popular stocks at relatively attractive valuations. These include many “quality growth” companies that have historically traded at a premium but now languish in the value camp. In many cases these are domestic consumption related businesses that should be less affected by global crosswinds. However the AI and gold stories play out, stocks like these could become future drivers of alpha.
