‘Tis the Season for Market Opportunities

By Dr. JoAnne Feeney, Partner & Portfolio Manager.

Happy Holidays to All!

‘Tis the Season when pundits far and wide put out stock market forecasts for 2024: just where will the S&P 500 finish? At 4,750? 5,000? 5,250? Or do we fall back to 4,500?  Or even (gasp) 4,000? As entertaining as this parlor game may be, we won’t be playing. Why not? Because you are not invested in the index known as the S&P 500. You are invested in a collection of companies, some of which are in the S&P 500 and some of which are not. Some are outside the US and others are smaller than those included in that large company index. We have often made the point that when you own a fund tracking such an index, you own it all: the good, the bad, and the ugly. And, even more importantly, you would own those stocks in proportions that reflect the past successes or failures of those companies. The weightings of those 500 or so stocks reflect the companies’ market capitalizations, so the more those stocks appreciated in the past, the larger their weights in the index. We think it makes more sense to select companies based on better relative future opportunities, rather than on past performance, with position sizes determined by our risk control measures, not according to the weights reflected in an unmanaged index.

This is even more true after a year like 2023, when the vast majority of the S&P 500’s increase was driven by a handful of companies, collectively known as the Magnificent 7. We have written several times about those stocks and their drivers, valuations, and impact on that index. A quick update: the group is responsible for over 60% of the rise in the market (the S&P 500) through last Friday and a fund tracking that index would have 28% of assets in the stocks of just those seven companies.[1] Not exactly a diversified collection. Nor cheap, as we have written in the past. But some of those companies do offer far more growth potential (because of persisting network effects) than most other companies can muster, and so some of them may continue to make sense for several of our strategies.

When we look beyond the Mag 7, we find some highly divergent paths of sales, profits, and stock performance over the past year. The explanations for the relative strength of the Magnificent 7 as compared to the weakness elsewhere range from the potential of artificial intelligence to the challenges of the mini-banking crisis, and many other dynamics as well. Reviews of the past have value, however, only in the opportunities they might unearth.

When we look for opportunities in 2024, we note that some of those areas which were particularly weak in 2023 may have room for recovery in 2024. Take slower growth, moderate dividend payers, for example. This would include most utilities, lots of consumer staples companies, and even some energy companies. This group was at a disadvantage in 2023 because of the rise in interest rates. When the 3-year Treasury yielded well over 4%, investors were inclined to switch out of even moderately risky utilities or staples to get even safer income. Yes, they were giving up any chance of growing principle with such a move, but that sacrifice was evidently worthwhile for a good sized subset of the investing public. That shift caused the dividend-paying stocks (tracked by SPYD) to badly lag not only the Mag 7-driven S&P 500 (SPY), but also the average stock in the S&P (RSP):

[1] Apple, Microsoft, Alphabet, Nvidia, Amazon, Meta, Tesla.
Source: Bloomberg, LLC.

But that underperformance and, more importantly, the reasons for it, reveal a potential opportunity for 2024 (and beyond). Once rate increases are expected to come to end and (eventually) to fall, the substitution effect should begin to reverse. When safer bonds no longer compete as well with modestly risky stocks in utilities and consumer staples segments, for example, we are likely to see investors switch back so they can continue to secure the income they like to have built into their portfolios. Moreover, after this year’s sell off, investors may also be drawn by more attractive valuations and greater appreciation potential.

Another example wherein 2023’s challenges may turn into 2024 opportunities can be found among some health care stocks, especially for life sciences equipment. Those companies suffered much slower sales than expected as higher interest rates delayed spending on new projects in drug discovery, therapeutics development, and pharmaceutical manufacturing.  Higher rates pushed up the total costs of financing those projects and caused many companies to defer them. The analytical tools needed in those programs were bought in far fewer numbers than expected. Tools already built languished in distributor inventories. Earnings fell, cash flow shrank. And stock valuations tumbled. And what happens when interest rates are expected to fall? Likely, just the opposite. Those inventories are clearing out and projects delayed become more attractive with the passage of time in the face of rising demand. Demographic trends continue to point to substantial demand growth for more advanced treatment protocols (yes, Boomers, I’m talking about your demand for medical advances to keep you running, skiing, and generally healthier than you otherwise would be). And that makes some of those stocks that sold off sharply this year particularly attractive now: better growth prospects and a cheaper valuation.

These examples are by no means exhaustive of the areas of the market where we see opportunities in 2024. And the path of interest rates is only one of many considerations for determining where those opportunities lie.  No one knows exactly when the Fed will begin to cut interest rates.  The inflation fight is not yet won. Labor markets have loosened some, but wage pressures remain a source of concern for inflation. Nevertheless, we are likely closer to Fed policy rate cuts than we have been for the last several months and longer term rates (such as on the 10-year Treasury) have already begun to fall. This is helping boost valuations for growth companies and may help give greater support to some of the areas of the market left behind in 2023.  So let the pundits have their fun; we’re going to continue to dive into the details of individual companies.

The foregoing content reflects the opinions of Advisors Capital Management, LLC and is subject to change at any time without notice. Content provided herein is for informational purposes only and should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. Past performance may not be indicative of future results. Indices are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses which would reduce returns. Securities investing involves risk, including the potential for loss of principal. There is no assurance that any investment plan or strategy will be successful.