Everybody's Knackered: Oil, Chips & Chokepoints
War expectations, a new era of trade disruption, and a chip-heavy Korean market flashing early. This week Steve, Tom and Jacob work through what the concentration in the US index really means, and why rebalancing matters more than ever.
Supply chains are back at the centre of the risk picture. War expectations and a new era of trade disruption put oil, chips and the chokepoints between them front and centre.
Watch Korea. Chip-heavy and export-sensitive, the Korean market tends to move first. A semiconductor selloff there is worth more of your attention than another record close on Wall Street.
The US index has rarely been this concentrated. Semiconductors now make up roughly 20% of the S&P 500, an all-time high, while the US CAPE sits at about 42.
Commodities relative to stocks are near multi-decade lows. Extreme relative valuations have often preceded a change of regime, even if the exact timing never announces itself.
Markets do not only go up. Stocks spend most of any cycle falling or clawing back, and only about 5% of the time at all-time highs. That is why rebalancing does the heavy lifting.
The week opened with war expectations moving back up the agenda. Markets have spent a while treating conflict risk as background noise. This week it moved closer to the foreground, and the second-order effects, energy prices, shipping routes, insurance, are where it tends to show up in portfolios first.
Underneath that sits a bigger structural story. The era of disruption is upon us. Global trade is being reorganised around security rather than pure efficiency, and that reorganisation is neither quick nor cheap. Tariffs, export controls and reshoring all pull in the same direction: higher costs, more friction, and supply chains that are more fragile than the ones built over the previous three decades.
And then there is Korea. Beware the message the Korean market is sending. Korea is one of the most chip-heavy, export-sensitive markets in the world, which makes it a useful early warning system. When semiconductors wobble globally, Korea often feels it first, and this week it did.
It is no surprise to anyone who has listened for a while that the US CAPE is now around 42, deep into the territory we have flagged repeatedly. The number itself is not the news. The composition underneath it is.
Recreated from Bloomberg and S&P Global data. Semiconductors have gone from a low single-digit share in the mid-2010s to roughly a fifth of the entire index, eclipsing even the dot com peak.
One sector at a fifth of the index means a great deal of your "diversified" US exposure is really a single bet on one industry's earnings holding up. Those earnings are already stretched. Forward S&P 500 earnings now sit at a record gap above their longer-run trend, and expected earnings growth of roughly 24% for the year is the sort of figure normally seen only coming out of a recession, not seven years into an expansion.
The wider economy has leaned into the same bet. On some estimates, AI-related investment is now contributing more than a quarter of US GDP growth, with that spending running at around 8% of GDP in level terms. When one theme is carrying the index, the earnings and a large slice of the economy all at once, the thing to watch is anywhere that theme shows early strain. This week, that was Korea.
The flip side of an expensive, concentrated equity market is that the unloved corners get cheaper the longer the crowd looks away. Commodities are the clearest example. Measured against equities, the commodities complex now sits near its lowest relative valuation in decades.
Recreated from Goldman Sachs Commodity Index and S&P 500 data. The ratio peaked around the Gulf War and the GFC, and now sits near the same depressed levels last seen before commodities entered their 2000s boom.
The history is the interesting part. In 1999, stocks were so dominant that commodities were treated as almost irrelevant, right before commodities entered a decade-long boom. By 2008 commodities were the consensus trade, and the GFC ended that cycle. Today, after years of equity outperformance driven by tech and then the AI theme, the ratio is back near multi-decade lows.
History does not repeat exactly, and none of this is a prediction about next quarter. But extreme relative valuations have frequently preceded regime shifts, and this is the sort of setup we would rather be early to than late. This is general commentary on where we see value across asset classes, not a recommendation to buy any particular security.
We want to push back on the belief that markets only go up over time. There are extended stretches when stocks go nowhere in real terms, and once inflation is taken into account, that means years of negative real returns while it feels like you are standing still.
Recreated from Research Affiliates data (Bloomberg, Shiller, Ibbotson, McQuarrie). The long-run trend rises, but it is punctuated by decades-long stretches where real prices went nowhere or fell.
Look at the shape rather than the destination. The line does trend up over two centuries, but it gets there through a series of long plateaus and drawdowns. Most of any market cycle is spent either falling or getting back to where prices already were. By the reckoning we walked through, stocks sit at all-time highs only around 5% of the time. The other 95% is spent below a prior peak.
That is the case for rebalancing, and it is the edge available to any patient investor. If you trim what has run hard and add to what the crowd has abandoned, you are working with the cycle rather than assuming a straight line that history says does not exist. Rebalancing is one of the few genuinely reliable contributors to long-term returns.
Pull the threads together and the picture is coherent. A more dangerous geopolitical backdrop, a trading system being rebuilt around security rather than efficiency, and an equity market whose returns, earnings and even national output all lean heavily on a single theme. Korea is the early tell. Commodities are the unloved mirror image. And two centuries of history are a reminder that going nowhere for a decade is a normal market outcome, not a freak one.
As always, this is general information about how we read markets, not personal advice tailored to your circumstances.
Steve: When one sector is a fifth of the index, that is not diversification, it is a concentrated bet wearing a diversified label. Know what you actually own.
Tom: Korea is doing the job of a canary. Cheap, unloved commodities are doing the opposite. Both are worth more attention than the next US record close.
Jacob: Rebalancing feels unglamorous and slightly uncomfortable every single time, which is exactly why it works. Set the rule before you need it.
This newsletter is for informational purposes only and does not constitute financial advice.
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