No bubble but ‘Goldilocks’ scenario already priced in

AI stocks are in the spotlight but slow and steady wins the race, says Schroders head of strategy for QEP global equities David Philpotts.

Schroders head of strategy for QEP global equities David Philpotts.

Artificial intelligence stocks are in the spotlight, but slow and steady wins the race over the long term, according to Schroders’ London-based head of strategy for QEP global equities, David Philpotts.

The $9.1bn Schroder QEP Global Core fund has outperformed its benchmark MSCI World index in 19 of 24 calendar years since inception, with an annualised relative return of 0.9 per cent before fees.

With its focus on value and quality, this highly diversified enhanced index fund has achieved consistently solid returns with less risk and less carbon intensity. The fund’s historical “win rate” in falling markets is 71 per cent, and its carbon intensity is 40 per cent less than the index.

Ahead of Tuesday’s release of US CPI data, expected to show that inflation remains too high for the Fed to start cutting interest rates at its meeting next week, Mr Philpotts said his focus on quality at a reasonable price did not preclude the so-called “Magnificent Seven” tech giants. But they have shot up in price this year and he saw plenty of growth opportunities outside the US.

Still, he said he didn’t see the AI boom as a repeat of the late ’90s “dotcom frenzy”.

Even with the S&P 500 up 7.6 per cent this year, after rising 24 per cent in 2023, he said valuations were “far more reasonable” than they were in the late ’90s and “not particularly expensive”.

Nvidia’s share price has risen about 273 per cent in the past 12 months, adding about $US1.6 trillion ($2.4 trillion) of market capitalisation. However, its next 12-month PE ratio has fallen to 35, from above 50.

“Because of its strong earnings growth, Nvidia is actually looking quite reasonable,” Mr Philpotts said.

“But the key question is how long that strong earnings growth keeps coming through.”

Markets were looking a “little overextended” albeit there was not an obvious catalyst for investors to jump off the AI bandwagon after a solid reporting season for the Magnificent Seven apart from Tesla.

A 30 per cent fall in Snowflake shares after its 2025 sales forecast missed estimates two weeks ago showed what can happen when tech stocks disappoint lofty expectations.

But apart from Tesla, the market has little doubt about the earnings trajectory of the tech ­giants.

With his background as an econometrician at the Bank of England in the early 1990s, Mr Philpotts knows the limitations of economic forecasting and the added difficulty of translating that into a strategy that financial markets agree with.

“My caveat is that hard landings look soft originally but it looks like we’re going to have something more like a Goldilocks scenario,” he said.

“But in terms of what that means for markets, I think we’re on the cusp now of moving beyond the fundamentals. I’m not saying we’re in a bubble, but you could argue there’s lots of good news in the price. We’ve got some uncertainty this year around elections and geopolitics more generally.”

Perhaps economic data will disappoint. In any case he sees scope for higher volatility. “I don’t know what the catalyst is going to be, but there’s a lot of good news in the price,” he said.

But while markets are looking a bit overextended, a short-term pullback probably could “restore a bit of breadth” to the market and provide a “firmer platform to build on”.

“In the early stages of bubbles, there’s often a big theme, like AI, there’s often a lot of liquidity – and it’s debatable how much liquidity is out there, but it doesn’t feel like we’re in a tight environment now,” Mr Philpotts said. “Normally in a bubble there’s an excessive amount of retail participation, which is not really the case now, despite some recent commentary about retail buying of Nvidia.

“We’re not seeing a retail buying frenzy like we have seen in the past, so you could argue the case for a melt-up from here.”

However, he said he doubts the global equity market has the kind of potential for sustained double-digit returns over the next decade that it had from the low starting point after the Global Financial Crisis.

“You could argue that it should be more expensive because it’s higher quality, it’s more profitable and that’s fuelling the earnings momentum, but there’s a point where you’re overpaying,” he said. “No one’s arguing that markets are cheap.

“You could say they’re fair value given the quality, particularly the US – but you’re not going to get that revaluation uplift we had post-GFC.

“The only way you’d get back to the double-digit annualised returns for global equities over the next decade is if the AI enthusiasts are correct and we get this major uplift in productivity.”

If AI is a game changer for productivity, it could lower inflation and allow companies to generate more earnings with the stock of capital and labour, but it will take a few years if that comes to pass.

“I’m not negative on global equities, I just don’t think it will be as good as it was,” he said.

In that context, he sees a better hunting ground for stock pickers outside the US.

“You could say it’s cheaper for a reason, outside the US, the cyclical risk is higher,” he said.

“But from a bottom-up point of view, rather than thinking about the chances of a major stimulus package in China, there is a lot of opportunity in emerging markets in general.

“There has been this toggle ­effect between India and China in terms of flow of funds – when China is underperforming the money flows to India – but it’s interesting that when China rebounded recently it didn’t dent enthusiasm for India. It is becoming the low-cost producer for the world.”

But with only a third of MSCI World stocks outperforming the index now, he said it was hard for active managers to beat the index unless they owned the stocks that were leading the index higher.

His fund is currently “modestly positive” on the Magnificent Seven, though he excludes Tesla from that group. Apple is his least favourite stock of the “Super Six”, as it has less growth potential.