Plus500 (PLUS) recently delivered preliminary figures that were ahead of expectations “despite lower levels of trading activity across global financial markets during the year”. The financial performance of the contracts-for-difference trading platform usually benefits whenever we witness increased volatility in global markets – and the opposite dynamic also holds true. So, the fall-away in trading activity duly fed through to increased margin pressure and falling cash flows. Nonetheless, the group’s operational progress last year, including the launch of a new sharedealing platform, should boost volumes over time (markets allowing) and its shareholders also stand to benefit from an additional $100mn (£78.8mn) in share buybacks.
This type of correlation may be unavoidable, at least in terms of financial performance, and it was certainly evident in the last statutory release from industry stablemate CMC Markets (CMCX), which detailed “a tough market environment, with low volatility offering fewer opportunities for clients”. Happily, a subsequent January trading update from CMC indicated that its financial performance in FY2024 was likely to beat analyst expectations due to increased contributions from its B2B and institutional segments.
These examples suggest that investors would be well advised not to place too much emphasis on the likely levels of volatility in markets, at least if you’re investing in these types of companies over the long haul. The way that these businesses perform during fallow periods will probably give a clearer indication of how efficiently they are being managed.
The chart below does show periods in which share prices for both these internationally focused companies have followed the trajectory of the CBOE Volatility (Vix) index, although the relationship is tenuous at best in relation to the share price record. The correlation coefficient for CMC implies that only 18 per cent of its share price movements have hinged on the ‘fear index’, while the relationship is even weaker where Plus500 is concerned. However, it is conceivable that a sustained period of volatility could produce a lagged effect in relation to share prices, raising the prospect of arbitrage opportunities.
Based on existing valuations, it’s unsurprising that some analysts believe that investors in US equities could be in for an increasingly bumpy ride going forwards. The major US indices have been simultaneously trading at, or near, their all-time highs. Trading multiples in the US are easily outstripping those of other advanced economies. However, there is no historical relationship between the valuations of stocks at the outset of a year and the returns that followed, while it could be argued that the premium afforded to US shares is justified given relative rates of return.
The base judgment is whether valuations for US stocks now exceed their intrinsic value or their projected earnings. This assessment has been made more problematic due to the top-heavy nature of the US indices. Yet of the so-called Magnificent Seven stocks that now dominate US index weightings, only Nvidia (US:NVDA) and Microsoft (US:MSFT) look richly valued based on their expected growth rates over the next five years, together with their target operating margins and cost of capital. Still, it’s generally held that valuations for several of the tech giants have been supported by the euphoria linked to the spread of artificial intelligence (AI). It’s said that history doesn't repeat itself, but it often rhymes, a point worth considering given that the clamour surrounding AI is worryingly reminiscent of the stock market bubble of the late-1990s.
But there are other considerations to take on board. By the time this magazine hits the newsstands, investors will be privy to the latest US core inflation figures – a precursor to the US Federal Reserve’s next deliberations on interest rates. The extent to which prospective rate cuts have been factored into stock valuations is difficult to gauge – the paring back of rate cut expectations has done little to hurt markets so far in 2024, but indices could come under pressure if the timetable for rate cuts is pushed back further still.
Perhaps the last word should belong to Warren Buffett. Berkshire Hathaway’s (US:BRK.B) cash pile hit a record $168bn at the end of last year, but the great man seems in no hurry to put it to work, bemoaning the lack of meaningful acquisition targets in his annual letter to shareholders – the first since vice-chairman Charlie Munger passed away in November. Whether this suggests that Buffett anticipates an upcoming correction is open to question, but it’s worth remembering that, small oscillations aside, the Vix has been in a downtrend since January 2022. That’s somewhat surprising given the journey of the S&P 500 over the past couple of years, but germane considering that the index is subject to mean reversion.
