Macroeconomics and politics
10 min read 8 Jan 24
The S&P 500 Index outperformed other stock markets once again in 2023. This time much of the performance was driven by 7 companies in the technology and consumer discretionary sectors - Tesla, Apple, Alphabet, Meta Platforms, Nvidia, Microsoft and Amazon. These companies now account for circa 30% of the index and have a market value higher than the stock markets of Japan, UK, China, and France combined. US equities are a pivotal market in the context of a portfolio. In this insight article, we explain why we think US equities could continue to do well this year but the risk-reward for long-term investors is less attractive than other equity regions.
We expect the global economy to continue to slow and global GDP growth for advanced economies will be around 1 – 1.5% this year1. We don’t expect a sharp downturn in the economy and we think investors’ focus on an impending recession is misplaced. Whether or not economic activity will contract to the level that it fits the official definition of recession is much less important to markets than some expect.
We think US equities will perform well this year because economic activity is mostly viewed in relative terms and the US appears stronger than other economies. With a resilient economy, US companies, particularly mid-sized companies, are more likely to be able to generate profits.
Current consensus growth forecasts:
Source: Consensus economics, as of November 2023
After a strong year for the mega-cap technology stocks they now account for 30% of the S&P 500 Index. Since they are a large part of the market, the view on the overall US stock market outlook must be informed by a view on these companies. While their valuations are expensive relative to other companies, we think the premium price is justified.
In an environment where global economic growth is slowing, investors are willing to pay up for companies that are able to grow profits. Between 2013 – and 2019 the magnificent 7 companies grew sales at 15% per year compared to just 2% for the other 493 companies in the S&P 500. This gap narrowed in 2021 and 2022 where all companies grew sales at a faster than normal rate but expectations for 2023 – 2025 are that this gap will widen once more. The ‘mag-7’ are expected to grow sales at 11% per year compared to 3% for the rest of the market2.
The chart below shows that US equities have consistently traded at a premium to equities from the rest of the world. Currently, the price to earnings ratio of US equities is 1.5 times higher. We expect this to continue because growth is expected to be higher.
US equity 12-month forward price-earnings ratio relative to rest of world
Source: LSEG Datastream, 01/01/2024
The lofty expectations for these companies to continue growing profits has set a high bar. In 2000 the bursting of the tech bubble and the underperformance of US companies occurred when companies failed to meet elevated growth expectations and valuations fell. Today, this would have similar effect because of their large weight in the US market. We see these risks emanating from different areas, such as:
A fall in the share price of these companies would act as a significant headwind for the S&P 500 index. For example a 20% fall in the collective ‘mag-7’ stock prices, would reduce the overall S&P 500 Index performance by 6%.
Investors' time horizon is key to asset allocation. Our investment strategy team focus on how they expect equity markets to evolve over the next 5 – 10 years. The US has delivered strong growth in recent years. We think the US will continue to trade at a premium to other markets because the corporate sector is more innovative, generates more profits and drives global productivity gains. However, we think the valuation compared to other markets is extreme – particularly relative to where GDP growth is likely to come from over the next 10 years.
We think it will pay for investors to focus on areas that are growing and are less expensive, such as Asia equities. China is a cheap, unloved market but remains a highly competitive economy with huge policy flexibility. It’s a leader in manufacturing supply chains particularly in battery technology.
India equities are supported by a young working-age population and the build out of service sector industries. Government policies to improve fiscal efficiency, increase infrastructure investment, reduce friction for trade between Indian states, and drive import substitution have improved the prospects for growth.
Korea and Taiwan are markets exposed to trade and technology. We have a positive long-term view on technology and the semiconductor supply chain as the world becomes increasingly digitised. The majority of the world’s semiconductors are supplied by Asia-Pacific where the region has competitive advantages as shown in the chart below. Other countries within the emerging market index are beneficiaries of supply chain diversification. Skilled labour and geographic proximity support the prospects for Indonesia, Mexico and Latin America.
Semiconductor industry revenues
We remain positive on US equities near-term but we think the risk-reward looking ahead over the next 5 years is poor and believe there is better value by investing in the cheaper structural sources of economic growth today.
1 World Economic Outlook, October 2023, IMF
2 Bank of America Merrill Lynch Research, 15/11/2023
Past performance is not a reliable indicator of future performance. The value of an investment can go down as well as up and your client may get back less than they’ve paid in.
Our model portfolio service can help advisers provide their clients with a cost effective way to invest while benefiting from active management, diversification and a wide range of ESG outcomes.
Explore the latest disclosure and regulatory information around how to complain, inducements, conflict of interest, Pillar 3 and the UK Stewardship Code.