Horizon Q1│2023 - Equities

In a nutshell

Limited earnings growth in 2024 is likely to limit upside potential for equities. Especially as valuations are unlikely to increase, at least in the US.
Europe and especially small caps have more potential for PE expansion, as a lot of the negative has already been priced in.
Our focus is on quality growth stocks, which should no longer be burdened by rising interest rates.
We continue to find value regions such as Latin America and the UK attractive as an addition.

Split fourth quarter

The setback we predicted for the autumn actually occurred. The major stock markets fell by more than 10% from their peak before a strong recovery rally began at the beginning of November – driven primarily by falling interest rates and lower volatility. Latin America continued its outperformance and remains one of the best performing regions worldwide. European equities caught up with US equities. By contrast, small caps and Asian emerging markets remain the relative losers in 2023.

Moderate, negative profit revisions likely for 2024

The consensus is optimistic and expects global profits to grow by around 9% in 2024, including margin expansion, after stagnating this year. We believe this is too ambitious for several reasons.
According to our economists, economic growth is likely to weaken in the first half of the year. Continued high wage inflation and rising corporate refinancing costs together with the now more pronounced onset of disinflation are also likely to limit profit growth. Against this backdrop, profit margins are likely to remain stable at best, meaning that profit growth should match sales growth. Accordingly, we expect global profit growth of 4–6% in 2024.

Valuation expansion probably only possible in Europe

The recent rally was strongly driven by valuations. The forward P/E ratio for the S&P 500 is now back at 19, above the historical average of 17. One driver has been the strong inflows this year into US funds and especially tech – the only equity sector with significant inflows this year, thanks to AI euphoria. This means that there is unlikely to be any major increase in valuations without a very sharp fall in interest rates. By contrast, other segments, such as European equities and small caps, are favourably valued compared to their own history. They are already pricing in an economic downturn and are underrepresented in international portfolios. If our economists are right and European growth accelerates again from the second quarter of 2024, not only profits but also the valuations of European companies are likely to rise. Small caps, which tend to be sensitive to interest rates, in particular have relative catch-up potential. On a P/E basis, European small caps are trading at a discount of 5% compared to large caps. If we were to return to the average of the last 20 years, small caps would have a relative catch-up potential of more than 20%. We view this as a major opportunity for 2024.

Aktienperformance S8 en — Time period: 11/12/2018–11/12/2023.

Latecomers are likely to perform better in 2024

In our opinion, market breadth is likely to increase again next year, giving the 2023 laggards the potential to catch up. This is supported by the fact that the "Magnificient 7" is a strong consensus trade that has seen many inflows in 2023 and the valuations partly anticipate the high earnings growth that can certainly be expected. In addition to small caps with healthy balance sheets, we particularly like companies from the healthcare sector and China-related stocks, such as luxury goods manufacturers. Our focus is clearly on European quality growth stocks, which are no longer facing headwinds from rising interest rates and should benefit from their above-average earnings growth rates. We continue to favour "value" regions such as Latin America and the UK for reasons of diversification. However, the upside potential is also limited by a low-risk premium for equities, only moderate 2024 earnings growth and signs that the market is already pricing in a soft landing. Overall, we therefore consider both the upside potential (earnings, valuations, optimistic investor sentiment) and the downside potential (positioning not extreme, central banks probably more supportive) for equities to be limited. A moderate setback in H1 after the strong rally since October 2023 in view of cooling economic data does not seem unlikely to us. Especially as the US presidential election campaign is also entering its hot phase. This is naturally likely to cause some volatility on the markets.

Grafik Equities 1 EN — Period: 30/11/2003–30/11/2023.

What is on companies' minds?

Positive signs

During our discussions with companies at conferences and one-on-one meetings, company leaders expressed very different perspectives on the coming year. In the semiconductor industry, there are increasing signs that demand should start to recover in 2024. The main drivers are the strong recovery in the storage media segment following the reduction of existing overcapacities. More positive voices are also being heard again from the private equity industry, as the environment for transactions is already brightening and the backlog of deals is also expected to clear in the coming year. In the luxury goods sector, on the other hand, the temporary slowdown in consumer spending, particularly in the US, became noticeable. However, the leading companies in the sector only see this as a temporary slowdown and not as a structural problem. Detached from economic data, the healthcare sector is currently dominated by the debates surrounding the new obesity drugs from Novo Nordisk and Eli Lilly and their expected negative impact on areas of medical technology. In conclusion, following the interest rate adjustments of recent months, the focus in 2024 is likely to be primarily on the economic development of companies.

- Matthias Born, CIO Equities