Mark LaMonica:Welcome to another edition of Market Minute. We have Ameya today. We are halfway through the calendar year and into a new financial year, so it would be a good time to take a step back and talk about what has happened with markets. Maybe just an update first.

Ameya Hattangadi: So I think what’s interesting to me is that if we look at the first half of this year, you notice that markets have been remarkably resilient. And I think what this shows is that the historical relationships that you might have expected in that type of environment just haven’t really played out as you might expect.

If we wind the clock back to six months ago, the start of the year, and we knew for a fact that we were going to have the largest energy supply shock in modern history, inflation expectations were going to rise, consumer inflation was going to accelerate from an already elevated level, and rate expectations were going to reprice from multiple rate cuts to at least one rate hike in this calendar year. And yet markets have been quite strong. The US market is up 10% year to date, the Taiwanese market is up 60% year to date, and Korea is up over 130%.

None of this resembles the relationships that you might normally expect in this type of environment. So what we’re seeing is something vastly different to what you might have expected in the past.

Mark: So obviously, I’m going to ask you to speculate. There are millions of investors out there making decisions, but why? Why do you think markets have been so resilient?

Ameya: Yeah. So this is interesting. Of course, there’s been a lot of focus on what’s happening in Iran and the geopolitical side of it. I think there’s also been a big focus on corporate earnings, which have surprised on the upside, and that’s actually driven forward multiples lower through the year.

We’ve also seen a bit of a broadening out in terms of market returns. So if you compare small-cap companies to large-cap companies, particularly in the US, we’ve seen small caps outperform by about 6%, and mid caps as well have done reasonably well comparatively versus large caps. They’re also up 9% relative to large caps.

The third point is that sentiment has dramatically shifted away from the Magnificent Seven. So we’ve seen this big shift towards semiconductor businesses. The Philadelphia Semiconductor Index, or the SOX Index, is up over 100% this year. Meanwhile, Nvidia is up only 7%. So there’s been this dramatic shift in the narrative from the Magnificent Seven to the semiconductor industry.

Mark: This might be a strange question to ask because you went through all these unexpected things in the first half and the market kept going higher. But what are the risks that are baked into the market today that investors should be concerned about?

Ameya: I think looking ahead, the next test for the markets will be second-quarter earnings. What’s interesting is that expectations have actually moved in a direction that’s somewhat unusual.

So let me explain that. Typically, what you see as the quarter progresses is that analysts trim their forecasts coming up to the reporting season. This provides management with a lower bar to clear and gives them some room for an upside surprise.

But what’s happened this quarter is that that dynamic has inverted. Analyst estimates for earnings have actually increased over the quarter. The US market now trades on a forward multiple that’s ahead of the five-year and ten-year historical averages.

So for these companies, they need to either achieve these lofty earnings expectations and justify their elevated valuations, or they fail to do so and disappoint. So the risk there, in our view, is quite binary. Companies either achieve those targets and do well, or they fail to do so and underperform.

Mark: And how do you position a portfolio given that binary nature of the risk? How do you guys position your portfolios to respond to these risks and the opportunities out there?

Ameya: So we like companies where the bar for management is quite low. We tend to fish in areas where companies have been hit hard and come under pressure. When there are different factors that all contribute to an equity sell-off or a stock sell-off, that’s when we get very excited.

So if you consider US consumer-facing businesses, for example, these businesses have come under a lot of pressure for a bunch of different reasons. Their input costs have gone up, consumer demand has come down because of the high cost of living, and Chinese demand is down. These are multinational businesses, so having a big market in China often has a significant impact on their fundamentals. You’ve also got the ongoing US tariff drag that’s impacting their businesses.

When all these factors come together, they really tend to impact share prices. As a result, these businesses are trading at low multiples and their earnings are temporarily depressed. But we think their fundamentals will normalise.

Examples include Nike, Burberry and Kering, which owns Gucci. These types of businesses have been hit significantly over the last months and years, but we believe that looking ahead, their fundamentals will start to revert and normalise over time.