Key themes for 2024 include market volatility
Reflecting on 2023, it emerges as a year marked by the resurgence of growth stocks, exemplified by the remarkable ascent of the “Magnificent Seven”.
Over the past year, the Russell 1000 growth index outpaced its value counterpart by an impressive margin of 31.2 per cent.
The growth index, propelled by a surge of more than 42 per cent, features tech giants Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla. Heightened interest in artificial intelligence played a pivotal role in driving valuations skyward throughout the year, given the substantial representation of these stocks in major benchmarks.
In a previous article titled “AI Drives Tech Titan Rally” (The Royal Gazette, June 27, 2023), I highlighted how AI was a driving force behind the success of the Magnificent Seven and the broader equity markets.
This trend gained momentum early last year as Microsoft’s joint venture, OpenAI subscription growth exploded, but reached peak velocity in May when leading AI chipmaker Nvidia announced first-quarter earnings that wildly exceeded analysts' expectations. Nvidia’s strategic investments in AI-focused chips solidified its position in parallel processing, establishing the company as a front-runner in the AI arms race.
While AI continues to chart a robust trajectory, market participants are likely to seek new leadership as we enter the new year. In that respect, end of year trends often serve as precursors to future developments. Since the recent market low on October 27, a more comprehensive rally has unfolded compared to the preceding ten months.
From the beginning of 2022, through last year’s late October market bottom, the S&P 500 market-weighted index outperformed its equal-weighted counterpart by a noteworthy 12.6 per cent.
However, the trend reversed from October 27 through year-end, with the equal-weighted index surging by 18.5 per cent, outpacing the market-weighted index, dominated by the Magnificent Seven, which registered a 16.2 per cent gain.
Within the information technology sector, semiconductors experienced a stellar year, benefiting from an upturn in their cycle and stabilising computer chip prices. Besides Nvidia, practically the entire semiconductor ecosystem stands to benefit from increased demand driven by data centre expansion and other requirements for processing and storing vast amounts of data.
While the market-weighted VanEck Semiconductor ETF has surpassed its high price reached last summer, the equal-weighted SPDR S&P Semiconductor ETF still trades below its all-time high, lagging the former by over 30 per cent in the past year. Similar to the broader market, smaller companies have room for catch-up against their larger peers.
In general, smaller company stocks collectively exhibit a favourable outlook for the coming months. Notwithstanding a year-end rally which returned small caps to positive territory, the sector trades at relatively modest price-earnings ratio of just 16.5x, presenting a 29 per cent discount compared with the larger cap S&P 500 index, trading at 22.9x trailing 12-month trailing earnings.
Mid-cap stocks, falling within the market capitalisation range of $2 billion to $10 billion, also appear poised for relative advances in the upcoming year. Bloomberg data indicates that the S&P 400 MidCap Index trades at approximately 18x trailing earnings, representing a 21 per cent discount to the S&P 500 index.
In terms of monetary policy, the Federal Reserve executed a notable pivot in December, transitioning from a perceived adversary to an ally as we approach the critical 2024 US election year. During the December meeting, the Fed appeared to be leaning into additional interest rate cuts in the months ahead.
Notably, however, the Fed's “dot plot” diverges significantly from market pricing. The Fed is projecting only three rate cuts of 0.25 per cent each, compared to the approximately six cuts or 1.5 per cent priced into the bond market at current levels.
Acknowledging a deceleration in inflation, the Fed now expresses equal concern for economic growth and employment. Although there appears to be no substantial weakening in the US economy yet, chairman Powell appears willing to support growth should the ongoing economic expansion face significant challenges.
Navigating a so-called “soft landing” may contribute to restoring Powell's credibility, tarnished by the central bank's historical misstep in 2021. At that time, the Federal Reserve in concert with America’s spendthrift government, caused the highest inflation in decades, largely due to overly aggressive monetary stimulus. This occurred shortly after public statements asserting the transitory nature of inflation. While political posturing may drive gains in the bond markets, investors must be cognizant of what is already priced in.
In fixed income, we advocate for a laddered portfolio approach using higher-grade corporate bonds on an issue-specific basis. Additionally, hybrid securities, offering longer duration exposure, could play an important role in balanced portfolios this year. Higher coupon issues with current yields of 5.5 per cent to 6.5 per cent annually provide a substantial buffer against the current inflation running at about three per cent. Within this fixed income subsector, we prefer electric utility and insurance company credits due to their inherently defensive characteristics.
Looking ahead into 2024, selectivity will be paramount as we navigate increasingly volatile markets. Potential sources of greater volatility include potentially destabilising national elections in 40 different countries, the Federal Reserve's unpredictable stance, multiple wars and escalating global trade tensions. These factors are likely to increase market volatility when combined with elevated equity valuations, especially for the largest companies.
Productivity will also be a crucial factor in security selection, with future market winners heavily influenced by their capacity to embrace advanced technologies such as AI, cybersecurity and robotics.
As the effects of extreme tightening measures by multiple global central banks reverberate through the world economy, businesses will need to work harder, faster and smarter.
In the year ahead, investors should look for reasonably valued companies with wide moats, strong balance sheets and shareholder-friendly policies.
• Bryan Dooley, CFA, is the Chief Investment Officer at LOM Asset Management Ltd in Bermuda. Please contact LOM at +1 441-292-5000 or visit www.lom.com for further information. This communication is for information purposes only. It is not intended as an offer or solicitation for the purchase or sale of any financial instrument, investment product or service. Readers should consult with their brokers if such information and or opinions would be in their best interest when making investment decisions. LOM is licensed to conduct investment business by the Bermuda Monetary Authority