Stock market returns have been particularly impressive in the US, especially so given the cautious sentiment resulting from the subpar economic outlook at the start of 2023.
However, gains are heavily concentrated in a small number of US mega-cap companies called the ‘Magnificent Seven’ that have benefited from the Artificial Intelligence (AI) boom. In 2023, the ‘Magnificent Seven’ (Apple, Microsoft, Alphabet, Amazon, Nvidia, Meta Platforms and Tesla) returned an incredible 107%, far outpacing the broader MSCI USA index, which delivered a relatively subdued, but still healthy, 27% to investors1.
The big winners of 2023 were the ‘Magnificent Seven’, with the traditionally more defensive sectors - consumer staples, healthcare and utilities - lagging behind. So, can the rest catch up?
Stock market performance could broaden
There are signs that this year there could be more opportunities beyond the Magnificent Seven. We expect the market to broaden for several reasons.
- A resilient US economy: Despite rising interest rates, company sales and earnings have been resilient. This can be attributed to businesses being more disciplined on managing their costs and households having higher levels of savings built up during the pandemic. In addition, the US labour market is healthy with nearly three million jobs added during 2023. Wages have risen with real take-home pay up over 4.2% over the past 12 months, while government handouts have also helped the poorest households. This should mean the robust consumer spending we have seen is set to continue and could drive up business sales.
- Improving margins: Companies have adeptly raised their prices, passing on the impact of higher inflation to their customers. Although wages have risen, they haven’t kept pace with those price rises, leading to a decline in employment costs as a proportion of the price of goods and services. Factors, including China joining the World Trade Organisation and technological advances, have enabled an increased supply of labour and accessibility to overseas job markets. This has contributed to improving profit margins, supporting earnings growth. We see this trend continuing.
Even if margins contracted slightly and there was only modest growth in company sales, our analysis suggests that company earnings could continue to grow. Consensus forecasts project 11% growth in earnings in 2024, which is possible. However, our base case is that company earnings in aggregate grow by around mid-single digits. Either way, we expect earnings growth to be positive in 2024.
Key risks and takeaways
Stock market concentration in the US is at its highest level since the 1970s2, with the ‘Magnificent Seven’ representing 28% of the S&P 500 index3. When a market is so narrowly focused on a small number of stocks and one theme in particular (AI), this clearly carries risks. The risk is the possibility of missed investment opportunities. There’s no doubt that the other 493 of the S&P 500 have struggled, but they could be on the up if the key drivers outlined above continue to fuel the economy.
War in Europe and the Middle East is an ongoing concern but despite the geopolitical risk the backdrop for stocks still looks positive.
Fears of a recession haven’t completely lifted, nonetheless, we think it likely that the US will avoid a sharp downturn due to its strong labour market, robust consumer spending and elevated company earnings.
Meanwhile, the broadening of performance in the others sectors of the market will depend on whether the US avoids a recession, and whether the Federal Reserve (Fed) cuts interest rates.
The Fed’s December economic projections indicated three potential interest rate cuts by the end of 2024, although there is speculation that the first won’t occur until May. This is to ensure the US economy continues to grow but is dependent on inflation remaining on track to hit the Central Bank’s 2% target.4
The US elections could create further volatility and the threat to investors will come from pre- and post-election risks. Pre-election risks include former president Donald Trump getting blocked from the Colorado primary ballot due to his alleged role in the Capitol riots in January 2021 and the repercussions from that, while post-election risks include the possibility of a contested election should the result be tight.
If Trump or president Joe Biden wins by a landslide, it’s likely to lessen post-election risk. However, if the election is tight, as we saw in 2020, then there’s a good chance that the loser may not admit defeat - social unrest is a possibility.
A threat for AI-led companies comes from regulators. For instance, Meta has faced multiple million-dollar lawsuits over its privacy settings and more recently, the European Union signalled that it is keen to rein in the market power tech giants like Alphabet, Amazon, Apple, Meta and Microsoft by applying a new set of pro-competition rules under the Digital Markets Act (DMA).
Given AI-led stocks’ stellar performance in 2023 and the beginning of this year, investors may feel inclined to continue to back them. But, if the rally starts to widen, investors could miss out on other opportunities beyond the Magnificent Seven stocks.
By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. This briefing does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. Details correct at time of writing.