Disruptive Growth – We see a base case scenario that is very compelling for growth equities
Risk assets did better in 2023 than many had expected at the start of the year as economic activity remained strong, driven by strength in the cash-rich consumer and the apparent taming of the inflation dragon. 2024 will not have the benefit of these two factors - in fact they may well prove to be headwinds as stubborn core inflation remains persistent and consumer cash levels run low. This latter factor is starting to show up in more depressed outlooks for discretionary spending – on a micro level visible in retail spending, payments volumes and basic services like food delivery.
The 2023 equity market picture was not all as robust as the headline numbers might suggest. While the S&P 500 index has tacked on close to 20% returns, the S&P equal-weighted index has hardly risen at all. Further down the risk curve, the Russell 2000 is also broadly flat for the year. Returns have been highly dependent on the “Magnificent 7” (M7) (Apple, Alphabet, Amazon, Meta, Microsoft, Nvidia, and Tesla). The Goldman Sachs mega-cap basket of stocks is up 70% year-to-date (at the time of writing)! Not owning these names has been a significant drag on performance. We believe there were three factors at play in the strength of these names. First, investors sought big, liquid, safe and relatively cheap equities. Second, heading into 2023, there was concern over economic growth and a good proportion of these names rely on economically sensitive revenues like advertising (Alphabet and Meta) or retail (Amazon). This led to some of the M7 being sold off at the end of 2022. Third, May 2023 saw the real results of ChatGPT’s launch late last year, with one of the biggest blowout earnings reports from any large company ever coming from Nvidia.
When we put all the 2023 drivers together we see a base case scenario that is very compelling for growth equities. It is likely that inflation will remain stubborn but in a more palatable range below 4-5%. This would allow interest rates to remain ‘peaked’. The mere sniff of softer economic growth in November and the more than 50 basis points decline in US 10-year yields led to a sharper move up in equities. Growth fundamentals have not blinked, with over 90% of S&P technology company earnings beating expectations in Q3 2023. We do not expect the next few quarters to be any different. Growth remains strong. However, the valuation of the M7 now appears stretched relative to the market. On the broadest measure, the S&P 500 trades on 18x 2024 expected earnings (Goldman Sachs); this is above the average levels of the last 30 years. However, the equal-weighted S&P trades at 14x 2024 earnings, at the lower end of the average 30-year range. The forward PE of the M7 names is 29x and this, we believe, is the key factor in our base case that growth equities will remain robust but that the winners will come from below the M7 names. The artificial intelligence (AI), healthcare, storage, and Software as a Service (SaaS) themes will drive the best returns, in our view – it is a bottom-up stock pickers’ market for 2024.
The wild card for disruptive growth will be China, where valuations have sunk to ridiculously low levels. Efforts to stimulate growth in the Chinese economy against a backdrop of ultra-low inflation should be rewarded with outsized returns in equities and for this reason, we believe the macro and geopolitical risks are more than priced in.
In summary, we believe growth equities will continue to perform well in 2024, led by names outside the M7, with China as a good risk/reward wildcard.
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