Apple’s China worries highlight risks of a narrow rally

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Shares in Apple, America’s largest company by market capitalization, fell 2.9% on Thursday, amid worries over moves by China to restrict the use of iPhones by government employees. The company’s value has now declined by USD 190 billion over the pat two trading days—equivalent to the market cap of the eleventh largest company in the Euro Stoxx 600 index.

The move underlines our view over the risks posed by the concentrated US stock rally this year, which has been dominated by gains in the largest technology companies. The NYSE FANG+ index, which tracks the top 10 most traded tech stocks, has advanced 74% so far this year, versus a gain of just 4.1% for the S&P 500 equal-weighted index, which dilutes the impact of these high-profile companies. As a result, setbacks in this small coterie of companies pose a risk to the broader rally.

To mitigate this threat, we recommend focusing on parts of the equity market that offer the greatest potential upside for the remainder of year and into 2024.

Favor US equal-weighted indexes over market-capitalization-weighted ones. The equal-weighted S&P 500 has lagged the main index, which is up 15.9% year to date, by almost 12 percentage points and we see room for catchup. In addition, the equal-weighted index has a greater exposure than the cap-weighted index to our most preferred US sectors of consumer staples and industrials, which we expect to outperform as the US economy continues to slow. Investors can also consider shifting to our other most preferred US sectors, like the lagging energy sector, which in our view doesn’t yet reflect the rebound in oil prices. Brent crude is trading close to USD 90 a barrel, up from a low of around USD 72 in late June.

Focus on parts of the tech sector that are less vulnerable to a slowing economy and have been left behind by the recent rally. Overall, the MSCI All Country World IT index trades at a relatively demanding 12-month forward price to earnings ratio of around 25 times, a near 30% premium to the average over the past decade. However, while we see headwinds for the sector more broadly, we see upside for investors in shifting exposure beyond the mega-cap stocks that have led the rally. We also think growth-based investors can use any potential near-term volatility in high-quality software stocks to accumulate long-term exposure, given our view that the industry is a clear beneficiary of broadening AI demand.

Add exposure to lagging emerging market equities. So far in 2023, the MSCI Emerging Market index is up just 1.8%, versus an 11.9% gain for the MSCI All Country World index. We expect a catchup, especially as China’s recent stimulus measures feed through into improving growth. Valuations are also appealing, with the EM index trading at just 11.8 times 12 month forward earnings, in line with its average for the past 15 years, while the broader global equity index trades at a 10% premium to its historical average over the period.

Within emerging markets, we particularly like Indian equities. Supportive macroeconomic factors include falling inflation, a narrowing external deficit, and improving purchasing managers’ indexes. We believe India's market valuation remains reasonable, while the corporate outlook looks healthy.

So, while the risks posed by the narrowness of the 2023 rally are real, we believe that investors can mitigate the threat by focusing on relatively neglected parts of the equity market, along with sectors that are less vulnerable to slowing economic growth.