picking the “winners” from the equity sectors
By Fook Hien Yap (Senior Investment Strategist, Standard Chartered).
The U.S.** hit an all-time high this year. However, the performance of different ** industries varies widely. Leading industries, including technology and communication services, are underpinned by a strong track record of earnings and revenue growth. We expect this earnings performance to continue this year. We also like the healthcare sector due to its earnings resilience in the economic cycle. As such, these three sectors form the core of our opportunistic allocation to enhance the overall investment return we receive from our underlying portfolio of diversified assets.
"Barbell Strategy".
Just as a barbell has weights at both ends, our plate selection has a "growth" plate at one end and a "defensive" plate at the other.
Driven by structural growth trends, growth sectors, namely technology and communication services, have historically shown higher earnings growth than other sectors. In the technology space, the transition to cloud computing will result in recurring revenue growth as customers increasingly subscribe to software service providers for their data storage and software needs. In our view, the semiconductor cycle is also improving, driven by AI-related investments, leading to significant backlogs for semiconductor producers. In the communication services space, the dominant ** and entertainment companies continue to attract consumers and grow in terms of digital advertising revenue. In both areas, technology platforms benefit from economies of scale, with margins improving as the business grows.
On the other hand, while our base case is a soft landing for the U.S. economy, the healthcare sector provides investors with a "defensive" exposure to balance the risk of a U.S. recession. Historically, earnings in the healthcare sector have been less volatile and revenue growth has less correlation with economic cycles. Valuations in the healthcare sector are also attractive. These characteristics allow the sector to integrate well with our preferred 'growth' sectors to enhance overall portfolio returns.
Leader in profitable growth
According to LSEG II B E S estimates, technology, communication services, and healthcare are expected to achieve the highest earnings growth of any industry in the U.S. by 2024. The 15%-17% earnings growth in these three segments exceeded the market's (overall) expectation of 10% growth. In 2023, much of the staggering US (26% return for the S&P 500) was due to valuation expansion, while earnings growth was only 4%. We expect the US** to continue to perform well in 2024, but more underpinned by earnings growth than valuation expansion. Our bullish three sectors are very much in line with this view, as their expected earnings growth in 2024 is very good.
Is it developing too fast, too much?
Admittedly, these three sectors have been among the best performing sectors in the S&P 500 this year. Our metrics on investor diversity and investor ** are a bit tight, which means there is a near-term risk for the U.S. For those who are already fully invested in the U.S.** and enjoying year-to-date gains, it would be prudent to reduce some of their excessive exposure by closing some profits. They may increase their exposure when they are **. Other investors who are not fully invested can wait until ** to increase their exposure.
For investors looking at 6-12 months, we believe earnings benefits will underpin the outperformance of the three sectors we like. Valuations in the US** (especially in tech stocks) have risen compared to historical averages, but we believe such valuations can be maintained as inflation continues to decline this year and investors are more certain about the likelihood of a Fed rate cut this year.
Key risks to watch out for include a slowdown in AI-driven investment, or a slowdown in the transition to cloud computing, which could affect much of the tech industry. Rising geopolitical tensions and barriers will also weigh on economic growth. At the same time, rising inflation expectations and rising bond yields are likely to weigh on valuations. In the U.S., the issue of healthcare costs could also be a political hot potato, and any adverse regulatory changes will affect the healthcare industry.
Overall, we believe the potential rewards outweigh the risks, as we see attractive returns from the technology, communication services, and healthcare sectors. A diversified portfolio, with opportunistic allocations in our chosen sectors, should allow long-term investors to stay invested through the economic cycle and outperform over time.
The views expressed in this article are for informational purposes only and are not intended as investment advice or solicitation