OMBA’s Sean Ashton: Rational perspective on Wall Street’s ‘Great Rotation’
In this interview, OMBA's Sean Ashton delves deeper into last week's research report, where he unpacked the relative appeal of investing in the traditional S&P500 index and its equally weighted cousin – explaining how it is essentially a call on the timeless debate of Growth vs Value. Ashton uses the example of superstock Nvidia to explain how there is no simple answer to the current conundrum investors face. He spoke to BizNews editor Alec Hogg.
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Highlights from the interview
In a recent interview on BizNews.com, Alec Hogg and Sean Ashton of OMBA addressed the potential shift in market dynamics known as the "great rotation." The conversation began with an analysis of the "Magnificent Seven," a group of high-performing tech stocks that have dominated market returns. Ashton attributed their outperformance primarily to robust earnings, highlighting Nvidia as a key example. Despite some concerns about these stocks peaking, Ashton noted that market concentration—where a few winners drive most returns—remains a consistent feature historically.
The dialogue then turned to the implications of falling interest rates and their potential benefits for smaller-cap stocks. Ashton acknowledged a recent shift towards small and mid-cap shares, illustrated by the Russell 2000's outperformance of the S&P 500. However, he cautioned that while smaller companies might see short-term gains, they aren't necessarily poised to become the next long-term growth leaders.
For S&P 500 investors, Ashton emphasized the importance of understanding market concentration and the emergence of new market leaders over time. He suggested that equal-weighted indices, which give all companies the same weighting, could be advantageous during certain market cycles, despite not being a consistently superior strategy.
Addressing a common investment mistake, Ashton agreed with Warren Buffett's advice to not sell winning stocks prematurely, as they significantly contribute to overall performance. He pointed out that companies like Nvidia, which rely on cyclical capital expenditures from others, face challenges in sustaining their earnings growth, particularly concerning the uncertain returns from AI investments.
Edited transcript of the interview
Alec Hogg (00:11.298)
The international media is full of stories about the great rotation that's supposedly about to occur. The Magnificent Seven have had a multi-year art performance, but are they coming to the end of their days of outperformance? Do we need to put money elsewhere? Sean Ashton from OMBA will be giving us the answers.
Alec Hogg (00:49.582)
Sean, as always, really good to be talking with you. Maybe we can start with the Magnificent Seven. Why have they been outperforming for so long?
Sean Ashton (00:53.489)
Good to be back.
Sean Ashton (01:03.399)
I think it's largely about earnings. There have been some pockets of re-rating, but the earnings outperformance from this group has been spectacular. Nvidia is probably the poster child for this phenomenon. Many might not be aware that its forward PE multiple is now around half of what it was at the end of 2021. So it's been an earnings story, largely driven by the massive CAPEX expenditure from their chip buyers.
Alec Hogg (01:44.448)
Artificial intelligence is hitting high points everywhere. But are you buying the story that the Magnificent Seven have had their run and it's time to start looking at smaller cap stocks in light of a potential cut in American interest rates?
Sean Ashton (02:07.495)
I think you always want to look across the market for opportunities. I don't believe the time in the sun is necessarily over. Market concentration has been at historically high levels. Index concentration is a feature, not a bug, with a few winners driving most of the market's returns. A recent chart showed that since 1926, the median stock hasn't delivered value; it's been like 4% of holdings delivering all the return.
Alec Hogg (03:02.814)
Hmm.
Sean Ashton (03:31.527)
Concentration has been historically high recently, with a few companies doing very well. At extremes, you can have periods of mean reversion and a natural snapback, which is what we've seen recently. Interest rates coming down will probably benefit smaller companies disproportionately. However, it's not necessarily that these smaller companies are the new secular growers.
Alec Hogg (05:42.556)
Mm.
Sean Ashton (05:53.927)
Recently, there's been a notable shift towards small and mid-cap shares. The Russell 2000, for instance, has outperformed the S&P 500 by about 11% month-to-date. This shift seems to be a relative positioning story, with high short interest driving share prices higher in a short time.
Alec Hogg (07:04.626)
Interesting. For amateur investors, technical changes can be confusing and potentially costly. What does this mean for someone with a big chunk of their portfolio in the S&P 500 index?
Sean Ashton (08:10.747)
That's right.
Sean Ashton (08:15.207)
For long-term S&P 500 investors, it's essential to understand that market concentration will remain high, but new leaders will emerge. Even if current top stocks change, over time, market concentration will persist.
Alec Hogg (09:14.275)
I'm listening.
Sean Ashton (09:21.575)
We segmented the entire S&P 500 into cohorts by average weighting and forecast consensus revenue and earnings growth for the next two years. The top companies are very expensive, with the top 10 having an average forward P/E of 40 times. However, as you go down the cohorts, smaller companies are growing slower, which is interesting. Larger companies today are delivering the fastest growth.
Alec Hogg (13:14.599)
So, investing in an equal-weighted S&P 500, where all 500 members get the same weighting, is an option. Why would that be a good trade?
Sean Ashton (13:21.179)
You're downweighting earnings momentum and size factor, aiming for broad exposure to America Inc. It's not a secularly good trade, but at certain points in a cycle, it can be beneficial. Equally weighted indices can catch up in performance quickly during market extremes.
Alec Hogg (15:08.8)
Interesting. I read in "The Essays of Warren Buffett" about selling winners. Buffett compares a portfolio to a bunch of basketball players, suggesting not to sell your best performers too soon. Your thoughts?
Sean Ashton (16:35.367)
I absolutely agree. Your best stocks contribute disproportionately to your performance. The mistake most investors make is cutting their winners too soon and adding to their losers. Winners earn a bigger place in your portfolio for a reason—they're operationally outperforming.
Alec Hogg (18:55.207)
Hmm.
Sean Ashton (18:55.207)
The challenge now is with companies like Nvidia, which has significantly increased its earnings base. Nvidia's business model relies on other people's CAPEX, which is cyclical. The risk is the sustainability of this earnings cycle. Questions about the payoff and return on investment from AI investments are being asked, but clear answers are not yet available.
Alec Hogg (21:50.925)
Fascinating insights from Sean Ashton of OMBA. I'm Alec Hogg from BizNews.com.
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