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Large-cap growth stocks delivered for investors this year, presenting big gains compared to other investment classes. Jere Wang of JR Research thinks this strong large-cap performance may stay intact in 2024.
Some beaten-down sectors – such as real estate, healthcare, automotive and consumer staples – may surface as attractive options next year. Tech stocks should remain in portfolios in 2024, Wang suggests, especially given continued interest in AI. But investors should remain diligent in stock selection in this key sector, along with analyzing any mid and small cap ideas.
All eyes will be on Fed actions in 2024, and that activity could shape how investors position during the year.
The Seeking Alpha analyst behind JR Research shares his assessment for the next 12 months below.
Seeking Alpha: A lot of analysts tend to lean toward growth or value-oriented stocks. You don’t seem to favor one over the other. But is there an equity class you see outperforming in 2024? Value vs. growth? Small cap vs. large cap?
Factor Performance (Morningstar)
JR Research: Large-cap growth has dominated the performance of the S&P 500 (SP500) over the past year, registering an impressive 30.7% gain. It has also trumped over mid- and small-cap growth as investors flocked to large caps and the magnificent seven in 2023. Buyers seeking a “safer harbor” as the Fed undertook its unprecedented rate hikes campaign have contributed to positive investor sentiment, given their more robust balance sheets.
Big companies have managed to dodge the high interest rates headwinds pretty well, as they secured “low-cost funding” before the rate surge. They also have more robust cash balances bolstering their interest income, benefiting from the high rates. As a result, it “resulted in a significant reduction in net interest payments for American companies.”
In addition, the dominance of the leading AI infrastructure and software players in market-leading positions to capitalize on the generative AI wave have also contributed to the outperformance.
However, since we know past performance does not necessarily indicate future performance, could the performance of large caps relative to their smaller peers (IWM) start to reverse in 2024?
I don’t think so. While the Fed is expected to have reached the end of its rate hike regime, it remains far from achieving its long-term inflation targets. As a result, a higher-for-longer Fed is expected to be the normalized posture that investors should consider, and not an FOMC looking to cut rates aggressively. Furthermore, recent economic data supports the view that the economy is not expected to fall into a hard landing in the near term. Therefore, it strengthens my conviction that the Fed will likely take a graduated and progressive approach to cutting rates, if any.
As a result, the strongest companies with the most sustainable competitive advantages and robust balance sheets are expected to continue their dominance.
SPY/IWM price chart (monthly) (TradingView)
In addition, my thesis is supported by the long-term price action seen in the monthly chart of NYSEARCA:SPY/IWM. The steep underperformance between March 2020 and March 2021 has normalized as the Fed embarked on its rate hike regime.
While bursts of relative outperformance from IWM are expected occasionally as investors execute portfolio rotations, I have not gleaned a sell signal similar to the bull trap in SPY/IWM in March 2020. The series of higher lows and higher highs in SPY/IWM is consistent with the long-term upward bias.
In other words, the market is likely confident that staying invested in large caps is a sound long-term strategy unless we expect the Fed to move into aggressive monetary easing. Since that seems unlikely, I expect the long-term uptrend of SPY/IWM to remain intact. Therefore, large-cap outperformance should continue. However, that doesn’t mean small caps will underperform consistently in 2024, as large-cap pullbacks are expected. However, stock picking will be pivotal for small-cap investors trying to outperform other investors who focus primarily on large-cap exposure.
SA: What are the contrarian opportunities investors should look at as they approach 2024?
JR: I believe the easy money in the tech sector (XLK) has been made in 2023, particularly in large caps. Therefore, some analysts have pointed out the possibility of rotating to beaten-down sectors like real estate (VNQ) (XLRE) and consumer staples (XLP), anticipating a market rotation away from tech.
Some consumer staples stocks have suffered as investors rotated out from companies assessed to have significant exposure to unanticipated headwinds from weight-loss drugs. As a result, the market worries that healthier eating and drinking habits could lead to a structural decline in the consumption of “less healthy” products. In the healthcare (XLV) space, med tech companies focusing on weight loss treatments/procedures have also been hurt by fears leading to a structural decline in customers seeking weight-loss procedures.
However, while there’s a basis for investors to price in uncertainties relating to these challenges, investors shouldn’t overreact to them. Notably, Novo Nordisk (NVO) CEO Lars Fruergaard Jørgensen stressed that these fears have “all gone a bit too far.” It’s notable because Novo Nordisk is one of the prime beneficiaries through its weight loss drug, Wegovy, as it competes with Eli Lilly (LLY) to define market leadership.
In the real estate sector, I believe there are significant opportunities for investors to capitalize as the Fed potentially reaches the end of its rate hike regime. Based on Morningstar’s sector valuation estimates, the real estate sector is tied with the communications sector (XLC) in their implied undervaluation (17% below fair valuation). However, investors must also temper their expectations accordingly, as the days of low interest rates are well over. As a result, I believe these sectors could remain materially undervalued until the market understands the Fed’s subsequent rate cut cadence, impacting the improvement in the cost of funds for the communication providers and cap rates for the real estate players. Notwithstanding these challenges, I believe it’s reasonable to pick high-quality stocks within these two sectors that could benefit, anticipating a Fed reversal in 2024.
SA: You cover the tech sector frequently, and AI continues to attract investor attention. Is there more to this story that investors are missing?
JR: I believe that the market is justified in lifting the valuations of large-cap tech in 2023 as the sector benefited from the wave of generative AI fervor. As a result, themes in the AI infrastructure space (picks-and-shovels plays), hyperscalers/cloud service providers, and AI application SaaS companies could continue to drive investor interest.
Strategist Edward Yardeni articulated (Nov. 27 brief) that increased high-tech spending reached a record seasonally adjusted annual figure of $1.84T in Q3’23. As a result, the spending represented a “record 50% of total capital spending in nominal GDP since the pandemic, up from about 25% during 1980.” Therefore, we could still be in the early innings of “productivity-driven” prosperity growth, underpinned by further advances in AI spending and innovation.
While I believe sector rotation to the beaten-down sectors is overdue, maintaining a sizable allocation to tech and growth stocks should underpin a diversified portfolio, given these secular opportunities.
SA: What impact do you think interest rates will have on investing in 2024?
JR: Interest rates will likely continue to dominate investor expectations in 2024 as the market assesses the timing of the Fed’s possible rate cuts. As a result, the deviation in performance between the beaten-down sectors in 2023 could close, depending on the pace of subsequent rate cuts.
The likelihood of another raise is increasingly unlikely unless the data suggests otherwise. Despite that, it would also be a new era of higher normalized interest rates that investors would find themselves in since the pandemic-driven bubble.
As a result, investors are expected to continue buying high-quality stocks with robust balance sheets and competitive advantages. Hence, I still expect large caps to outperform, even though small caps could initiate a much-needed reversal from their battering. In other words, I expect a more balanced investment climate than in 2023, when large-caps and tech-dominated.
SA: What market trends do you expect to play out in 2024?
JR: The inflation dynamics will be increasingly less of a headwind in 2024. Astute dip buyers pounced on a market recovery at the end of 2022 or the start of 2023, even though we didn’t have any clear signals that the Fed could be near its peak rate hikes. Therefore, these buyers defied Wall Street strategists’ bearish consensus views earlier this year. In addition, economists no longer view a recession as the consensus view. However, investors who waited for a more constructive view from Wall Street have missed the most attractive risk/reward opportunities presented in late 2022.
Moving ahead, I believe the risk/reward will be increasingly more challenging as Wall Street turns increasingly constructive. Stock-picking skills will likely be crucial as the market has likely already priced in a more constructive Fed at the current levels.
In healthcare, I believe investors will continue to pay close attention to the developments of GLP-1 drugs. The relative outperformance of NVO and LLY could come under increased scrutiny, given the underperformance of their big pharma peers. Investor interest could also turn to gene editing stocks as the FDA looks set to approve the sickle cell disease treatment using CRISPR technology, a significant commercial breakthrough.
In real estate, investors will assess whether office landlords could avoid a wave of defaults that could devastate the market and hamper confidence in affected lenders. The Wall Street Journal reported that only one-third of “securitized office mortgages that expired during the first nine months of 2023 was paid off by the end of September, a historically low rate.”
In technology, I believe the generative AI theme will continue to drive investor sentiment. However, as highlighted earlier, the easy money seems to have been made, suggesting more circumspect stock-picking will be necessary.
In the automotive industry, I believe 2024 will be a year where the strongest companies surge further ahead, leaving behind companies struggling to deal with the transition. In addition, even pure-play EV companies struggling to ramp their production rapidly could face their moment of reckoning as investors move on from these speculative setups. A shake-out could be imminent as investors assess the winners from the losers.