A Stock Pickers Guide To 2024
Episode Description:
In 2023, global equity markets experienced a notable surge, driven by resilient economic growth and increased investor confidence, setting an optimistic tone for the forthcoming year. In particular, U.S. equity performance surprised investors, but with higher rates and inflation, coupled with rising geopolitical tensions, still top-of-mind, can the solid performance continue and how might these impact markets in 2024? Joining host Oscar Pulido is BlackRock's Global CIO of Fundamental Equities, Tony DeSpirito. Tony will break down the headlines and provide his stock picks for 2024.
Sources: The Conference Board US Economic Outlook, 2022-2025 (Dec); Bureau of Labor Statistics, November 2023
Written Disclosures in Episode Description:
This content is for informational purposes only and is not an offer or a solicitation. Reliance upon information in this material is at the sole discretion of the listener.
For full disclosures go to Blackrock.com/corporate/compliance/bid-disclosures
TRANSCRIPT:
<<THEME MUSIC>>
Oscar Pulido: Welcome to The Bid, where we break down what's happening in the markets and explore the forces changing the economy and finance. I'm your host, Oscar Pulido. In 2023, global equity markets experienced a notable surge driven by resilient economic growth and increased investor confidence. Setting an optimistic tone for the forthcoming year.
In particular, US equity returns pleasantly surprised investors, but with higher rates and inflation coupled with rising geopolitical tension still top of mind, can the solid performance continue and how might these topics impact markets in 2024?
Tony DeSpirito: If there's anything I've learned over my 30 or so years of investing, it's to expect the unexpected. I'd have to say We're still in the late innings of the economic cycle.Employment's rather full, there's not a lot of slack in the economy, and the Fed's job is a tough one.
Oscar Pulido: Today I welcome back a Bid regular BlackRock's global CIO of fundamental equities, Tony DeSpirito. Tony will break down the headlines and his stock Pickers guide to 2024. Tony, thank you so much for joining us on The Bid.
Tony DeSpirito: Thank you, Oscar. It's great to be here again.
Oscar Pulido: Tony, as we look ahead to 2024 and your expectations for the stock market, maybe we can first start with, how the equity markets defied expectations in 2023.
Tony DeSpirito: That's a great way of, putting it defying expectations. And if there's anything I've learned over my 30 or so years of investing, it's to expect the unexpected. Let's scroll back to the beginning of 2023, inflation was running at about 6.5%, the Fed was in the middle of its biggest hiking cycle, in the last 40 years, and you could describe investors as at best, cautious, and maybe even fearful.
You fast forward to where we are today, things worked out remarkably well. First in terms of inflation, it's running at less than half of what it was running at last year, so the Fed tightenings having a real impact there. But where we haven't seen a big impact is on the economy itself. If you look at the economy and the jobs market, that's remained really solid. In fact, we're probably going to end this year at about 2.5% GDP growth. The latest unemployment report was 3.7%, very healthy.
And then you look at markets and even if you look at the equally weighted S&P500 index, the market has climbed that proverbial wall of worry, if you will. Now it wasn't without some wobbles along the way, we had a banking crisis back in March. It's hard to remember now.
So it wasn't, without its wobbles, but certainly when you look at the year on the whole, you'd say the returns look quite normal. The economy looks quite healthy and inflation's about where, almost where we want it to
Oscar Pulido: And it's interesting you mentioned interest rates mention inflation, the economy, I might even add geopolitics. Those are topics that we touched on in 2023, but it seems like these are also some of the main topics going into 2024. So, tell us again where you fall on these various topics and what does it mean for equity investing?
Tony DeSpirito: I represent Fundamental Equities and we're not macro forecasters. We're bottoms up stock pickers. we're looking for good businesses at good prices that we want to own for the next three to five years, that's our investment horizon. That said, it's important to recognize where we are in the cycle.
I'd have to say we're still in the late innings of the economic cycle. That doesn't mean I'm forecasting a recession or preparing for recession. It just means we're in the later innings. the later innings are when employment's rather full, there's not a lot of slack in the economy, and the Fed's job is a tough one, to be quite honest, If the Fed tightens too much or for too long, we risk a recession, and if the Fed tightens too little or rolls back, some of those increases too quickly, we risk inflation coming back. And so, we're at that point in the cycle where you got to pull out your late cycle playbook as an investor. And to me what that means is you want to go up the scale in quality. Quality, I think about good businesses. I think about really strong balance sheets. And I think about buying at fair or good valuations, good prices. As you do that, the implication for investors is that you'll be okay no matter what the macro environment turns out. And I think that was the lesson from 2023, to be quite honest.
Oscar Pulido: The environment you describe, seems to imply that investors should be selective. You mentioned quality as a characteristic, but perhaps in the later, stages of economic cycle, selectivity is important, and this actually rhymes with what Alex Brazier has talked about from the BlackRock Investment Institute, which is this need to be agile in terms of your investment approach. So where should investors start in 2024 when they think about the stock market, particularly because a lot of them were very focused on cash at the beginning of 2023, should their mindset change as they go into the new year?
Tony DeSpirito: Well, this issue of selectivity, I think it's going to be a multi-year issue. I don't think it's going to be an issue for just 2024. I think we need to look back in history a little bit. We've talked a lot about this is a new era of investing. And I think what we really mean is that we're going back to old eras. I think about that period, post the global financial crisis all the way through till the end of 2021, when the Fed first realized it was behind the curve on inflation and rates. I call that the 'post global financial crisis' period.
It was incredibly unique by any historical standards. It was a period that was characterized by excess supply, too many empty houses, too many unemployed people, too many goods coming from all over the world in terms of low-cost geographies, and it meant not enough demand to soak up all that supply. The Fed's job was to fight deflation to constantly come to the rescue, to markets with low interest rates, quantitative easing, et cetera. The result of all that was extremely high equity returns, particularly in the US equity returns were about double historical averages for that entire period on average. Wow, that's a long time!
And not only were equity returns super high, but volatility was really low versus history. So, it was a proverbial free lunch, way better returns at slightly better volatility. I. That meant you really need to make one decision, buy the S&P500 in the low-cost way and forget it. We're in a very different environment now, I think BII has done a very good job of describing this. We're in an environment where it's no longer excess supply, now it's not enough supply. Some of that's demographics, the baby boom's retiring and that's having an impact. Some of it is, we're going through a massive transition with decarbonization. Eventually that's going to help on the cost side, but there’s going to be a number of years where we're just spending a lot of money, and that's inflationary.
Then finally, think about globalization. We've reached peak globalization. Now we're in a period of deglobalization. We're in a period of rethinking supply chains. That too means higher costs, more inflation. And so, the fed's battle is going to be dramatically different going forward. It's going to be about fighting inflation instead of deflation. inflation will come and go, but that'll be the fight that'll be ongoing. What that means is more stock volatility. So, I think this is a really good environment for people who do what I do, stock pickers, fundamental equities, because of two things.
One is if you think about returns are going to be more normalized. That means alpha is going to be a more important part of portfolios. So, they're going to seek excess returns, they're going to seek active managers, and at the same time, when you think about volatility, volatility's really good for what I do. If you're a skilled stock picker, volatility is your friend. Now and I use the words carefully, skilled stock picker, because we all know, alpha's a zero-sum game, but if you're skilled in a volatile environment, you'll do better than average. And so, when I look at that, I think that's what's important for investors is to stay invested in the market. 2023 taught you that if nothing else and be active.
Oscar Pulido: Most people don't associate volatility being your friend, but as you point that out, because you're saying in your line of business when you have volatility, you have opportunity to identify some of those companies that could perhaps, do better than the normalized returns that you think we're going to experience going forward. I think in the past when you and I have spoken, you've talked about particular sectors that interest you. I know healthcare has been one of those sectors. Is that still an area of interest for you as you look ahead into the new year?
Tony DeSpirito: It totally is. What do I like about healthcare? first of all, demand long-term demand is solid. And that goes back to demographics. We're aging as a society, and as you get older, you consume exponential amounts of healthcare. So, the demand is there, the growth is there It's a sector with a lot of innovation, a lot of high-quality companies. And then it's also a very resilient sector. Think about a recession. You don't stop going to the doctors just because we're in a recession. You don't stop getting sick just because we're in a recession. So, it's a very resilient sector, and yet, despite the fact that has all these great characteristics, the valuations are quite attractive. Lower multiples than the average stock, in the S&P500.
The last point is about stock picking, there's a lot of variation. There are some winners and there's some losers in the healthcare sector. And so, I think it's not only a good sector to own overall, but it's also a really good sector for stock pickers.
Oscar Pulido: Tony, hopefully you've been listening to the podcast, not only when you're on as a guest-
Tony DeSpirito: I do, I listen all the time as I'm walking my dog!
Oscar Pulido: Fantastic, well, I'm sure you've heard a podcast or two around the topic of artificial intelligence. We've talked a lot about AI on The Bid this year, which, is obviously then an investment in the tech sector for those wanting to invest in that theme. How do you see that as an opportunity set in 2024?
Tony DeSpirito: The tech sector is another area where there's a lot of dispersion, a lot of opportunity for stock pickers. And I think artificial intelligence is going to be the topic for the next 20 years. It's one of the biggest things going on, just like the internet and the smartphone was over the last 20 years. But I don't think this is going to be an area where it's about, set it and forget it.
One of the ways we think about it is in terms of a tech stack, if you will, at the bottom level, there's the hardware, there are the chips, the servers, the cloud providers going up a layer, the large language models. Above that data and above that new business models that have yet to be developed. Right now, the winners have been basically in that hardware layer, the chips, maybe some of the server, producers, maybe, the cloud providers. And I think going forward, what's going to win is finding areas of technology that the impact of AI is just underappreciated. and that's what the opportunity set is going forward.
Let me give you a couple examples of what I mean by that. One Is in the memory area. So, if you think about the memory business, it's a growth business. We consume more and more memory over time, but it's a cyclical business. There are up cycles, there are down cycles while the general trend is up. Right now, we're actually in the middle of a down cycle. Probably around the trough. So, I think cyclically it's good time to invest in memory. But AI is a total memory hog. In fact, you actually have to use specialized memory in many cases, high bandwidth memory. So, I think about it as, okay, there's a potential for a normal upcycle, that's good, but with Ai, there's a potential for a super cycle on the way up that's even better. So, I think this is an underappreciated area of artificial intelligence -memory.
Another area where our investors are scouring is looking at companies that have unique data sets. If you think about training large language models on publicly available data, that's going to become commoditized. Everyone has access to that. What's really interesting is when you have proprietary data and AI makes that proprietary data even more valuable than it already is. And so, we're looking for companies with proprietary data sets that can be made more valuable by AI that'll then allow those companies to price up for their data. So those are some examples of hidden opportunities, if you will. Eventually we'll start getting new business models, et cetera. But that's still to come.
Oscar Pulido: So, what you're saying is AI is an investible theme, but the way in which you can best access those returns, or the more interesting investment opportunities might be different companies in the years ahead than what have been the winners so far. And that'll be a rotating process based on how business models are evolving.
Tony DeSpirito: Exactly. And that's how the internet played out.
Oscar Pulido: You talked about, deglobalization. We went through this period where, supply chains broadened that across the world, and now we're seeing that reversing, there's another term that often comes up, which I think is, reshoring, that seems to be related. Maybe you can talk a little bit about those themes, just what's going on geopolitically and how do you think about investing in these themes.
Tony DeSpirito: So, let's look back historically. Supply chains were built for maximum cost efficiency. not for resiliency. And that worked pretty well until we got to Covid. What we saw was all of a sudden that was a problem, we went too far. And that combined with some of the things that are going on geopolitically have really created an incentive for companies to rethink their supply chains. Some of it I would call reshoring, some of it I would call friend shoring, moving to economies like Mexico or India, which we're closer with. Some of it's actually bringing it back here to the US. Certainly, government has played a role in this too, we've had three major acts. We've had the inflation Reduction Act, the Chips Act, and even the Infrastructure Act. I think all of these are encouraging companies to bring more production back, to the US and so that's a really playable theme. But again, there's going to be winners and losers.
Take electric vehicles. for instance, the Inflation Reduction Act subsidizes the purchase of EV vehicles, but there's a requirement in order to get that $7,500 subsidy, a large part of the vehicle has to be made in the United States or in NAFTA, particularly the critical battery components. Some cars qualify, some don't. And so, if you look through the car manufacturers, some have a long list of vehicles that qualify, and some don't. The ones that don't, they're going to be the relative losers. For example. Another comment on geopolitics is certainly over the last two years we've seen the world; it's potentially becoming a less safe place rather than a more safe place. And so, I do think defense is also an interesting theme that would include here under geopolitics. Defense companies are very reasonably valued, less than the market, yet when you think about the growth opportunities in defense, they're probably going up, not down.
Oscar Pulido: It's interesting to hear you talk about these very high-level themes, but then distill it down to very particular sectors and industries and then ultimately companies that you're identifying that benefit from these themes.
If I could ask you to maybe take your passport out and take us outside the US for You have a global view on the world from your seat as a chief investment officer, where do you see the investment opportunities on the international stage outside the US?
Tony DeSpirito: So, I think the markets globally are quite interesting. Japan is definitely an interesting market. One of the things I do is I run an assembly of our US portfolio managers every other week. For two weeks in a row the topic, which the individual members portfolio managers set, was around Japan.
If you look at Japan valuations, they're pretty attractive. But what's really interesting about Japan is profitability. Japanese companies have been less profitable than their developed market peers around the world. Part of that's because of the deflationary spiral they've been in, and that looks like it's getting resolved, part of it is company will. and what we're seeing is both governments and stock exchanges there putting a lot of pressure on companies to become more efficient. and so, we're starting to see companies get away from the conglomerate structure, we're starting to see them deploy cash that's just been sitting on their balance sheets, not earning a lot. And so, we're starting to see that ROE, the return on equity going up for these companies and then becoming more profitable. That's where the real opportunity is. And then as I look across the globe, two big themes I’ll talk about.
One is in energy, what I see is a really big valuation dislocation. The US integrated oil companies are much more highly valued than the European and UK integrated oil companies, despite the fact that when you look at the underlying businesses, they're actually quite similar. And over the last couple of years, the Europeans have become much better capital allocators than they were historically. So, I think that's a really exploitable valuation opportunity. That gap has started to close actually in 2023, but I think it has a long ways to go.
Another gap is a quality gap, so when I look at, US pharmaceutical companies versus European, the, they're similarly valued, but the Europeans have way higher quality, particularly when it comes to patent expirations. the US large pharmaceutical companies have a number of upcoming patent expirations. That's a lot less so true for Europeans. And then the R&D pipeline is way more robust in Europe. actually, we talked about healthcare earlier, it has not been a great sector in 2023, but we avoided the value traps of US large cap pharmaceuticals deploying the cash. In some of the obesity drugs, deploying the cash in some medical devices and some European pharmaceuticals. So again, very much about stock selection.
Oscar Pulido: Tony, we spend a lot of time thinking about the year ahead,
Tony DeSpirito:
Oscar Pulido: and of course, when it's a new year, it's always a time for reflection. you've had a long career, of investing and you have a lot of history that you've brought into the discussion What are some things right now that you would tell investors reflecting back on many market cycles in the past, as we go into 2024 are there any lessons that you've learned that you think are important to keep in mind right now?
Tony DeSpirito: Let me pass along what I think is some Wisdom about, growing your wealth. Improving your retirement over time. And first of all, it's about savings, you should save like a pessimist. There's a Chinese expression The best time to plant a tree is 20 years ago. The next best time is today. So, I encourage everyone to save as much as you can for your future.
Also don't try to time the market. We have an expression around here. It's about time in the market, not about timing the market. And I think that's really true. And if nothing else, 2023 is a great example of that. I think a lot of people would've thought, oh, this would be a great year to sit things out. Turned out to be a horrible time to sit things out and not being in the market. And then finally, I think the best advice is yes, participate in the market, but do so in a prudent way, don't do it in a speculative way. The more prudent, the more resilient your portfolio is, the more likely you are to stick with it and that's the key. Get rich slowly, not fast.
Oscar Pulido: As usual, these are great insights. I hope you'll listen to them the next time you're walking your dog, and listen to some of your own advice, Tony. But thank you again for joining us on The Bid.
Tony DeSpirito: Thank you, Oscar. It was my pleasure.
Oscar Pulido: Thanks for listening. to this episode of The Bid. Next week, be sure to tune in and check out my conversation with Jeff Spiegel, where he'll provide a holistic overview of major investment themes to help investors navigate the year ahead.
<<THEME MUSIC>>
<<SPOKEN DISCLOSURES>>
This content is for informational purposes only and is not an offer or a solicitation. Reliance upon information in this material is at the sole discretion of the listener.
For full disclosures go to Blackrock.com/corporate/compliance/bid-disclosures
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