As the calendar progresses towards the year-end holidays, U.S. equity investors have much to rejoice in. For the second consecutive year, the S&P 500® Index has appreciated by more than 20%, a pattern that hasn’t occurred since the 1995-1999 golden era. At the end of November, MSCI reported U.S. equities accounted for more than two-thirds of the weight of the MSCI All Country World® Index, up from 59% at the end of 2022 – indicating substantial outperformance relative to other regions. Through early December, it has been a much better year for equities than experts predicted 12 months ago.
Note: Wall Street firms included in the estimates are Bank of America, Barclays, BMO, Deutsche Bank, Goldman Sachs, JP Morgan, Morgan Stanley and UBS. Data as of 12/06/2024.
Source: FactSet® and Bloomberg
The challenge of market predictions
For the fifth consecutive year, a range of Wall Street strategists’ forecasts for year-end S&P 500 Index levels did not bracket the outcome. If the year ended on December 6, the average beginning-of-year forecast fell 22% below the actual result, while even the highest forecast was 16% too conservative. This observation is not intended to shame our well-intentioned industry brethren; it does however once again demonstrate the great difficulties in predicting a point estimate for market returns for a given year. For what it’s worth, these same strategists have established a range for year-end 2025 that would equate to a 7-15% increase (the average is 9%) for the S&P 500 Index from current levels. Based on current consensus expectations of 15% earnings per share (EPS) growth for the S&P 500 Index in 2025, these forecasts assume some minor forward P/E multiple contraction from the 22.4x level of December 6. Relative to history, current valuation is elevated, with the market multiple having expanded from 16.7x at the end of 2022. It’s important to note that this multiple expansion is not simply a reflection of the Magnificent Seven’s growing popularity over the past two years; two-thirds of S&P 500 Index constituents have seen multiple uplift over this timeframe, with more than 40% currently trading at multiples at least 20% above year-end 2022 levels. In total the median P/E multiple expansion of all S&P 500 Index companies since end of 2022 has been 13% per FactSet data.
Source: FactSet as of 12/06/2024.
It’s not just about the Magnificent Seven
2024 can be split into two distinct periods – both from a market leadership standpoint as well as for active managers in the large growth and core arenas. From the start of the year through July 10, the majority of Russell 1000 Growth® Index and S&P 500 Index returns came from the Magnificent Seven. According to FactSet, these mega-cap technology-oriented stocks contributed more than three-quarters of the Russell 1000 Growth Index return year-to-date through July 10, and more than 60% of the S&P 500 Index return. During this same timeframe, fewer than one in three active managers who compete with these indices outperformed. On the morning of July 11, the June Consumer Price Index (CPI) report was released, showing a month-over-month decline in prices for the first time in four years, increasing confidence that the U.S. central bank would initiate a rate-cutting cycle. Since then, the market has demonstrated greater breadth, while more active U.S. large cap managers have beaten their targeted benchmarks. For instance, our Large-Cap Growth strategy has outperformed the Russell 1000 Growth Index by more than 300 net basis points (bps) while the Flexible Equity strategy has beaten the S&P 500 Index by roughly 200 net bps during this period. While U.S. equity markets during the second half of 2024 are not exhibiting truly broad market leadership, there has been greater balance across sectors while technology sector performance has lagged the market.
Source: FactSet and Morningstar
While the Magnificent Seven are often considered a proxy for Generative AI stock performance, they do not come close to speaking for that entire theme, especially when considering 2024 stock returns. Only one of the top dozen performers in the S&P 500 Index this year is among the Magnificent Seven (NVDA), and only three reside in the technology sector, yet I would posit that two-thirds of them are in fact Generative AI “plays”. Earlier this year we discussed how independent power producers such as Vistra, Constellation and NRG Energy are beneficiaries of the rise in power demand associated with the data center buildout. However, other non-traditional Gen AI investments exist as well. Texas Pacific Land owns vast acreage across the Permian Basin, home to very low-cost natural gas production and could become prime real estate for data center development. Targa Resources is a natural gas midstream company with gathering and processing assets, the majority of which are in the Permian Basin. Perhaps the most fascinating story is Axon Enterprise, known for its TASER devices utilized by law enforcement agencies, which now leverages Gen AI to create police reports based on information from its body cameras. These incident summaries save considerable officer time, and importantly are monetizable, significantly accelerating the company’s top line growth rate. Finally, while not true “plays” on Gen AI, companies like United Airlines and Royal Caribbean have incorporated AI into their business practices (operations and pricing strategies, respectively). Thus, while the world watches and waits to see if hyperscalers like Amazon, Microsoft and Alphabet are eventually able to earn an impressive return on investment associated with this technological advancement, there are companies beyond the mega-cap technology universe that carry a high probability to fundamentally benefit from it.
Source: FactSet as of 12/06/2024.
The impact of ‘one-liners’
The equity market’s first-month response to the presidential election outcome has generally been favorable, with both the Russell 1000® Index and the Russell 2000® Index up 6-7%, and only the healthcare and materials sectors in decline (both by 2%). Outside of Tesla’s (TSLA) 55% climb over this period, the most interesting (and exhausting) impact on stocks has been the daily volatility of securities based on one-liners from the incoming administration. Comments about tariffs on Mexico, Dogecoin (DOGE) price negotiations and even thoughts on weight loss drugs have rattled investors’ perspectives on individual stocks and even entire subsectors on an almost daily basis since the election. While there has been a great deal of rhetoric around these topics and more, the president-elect has yet to take office, and the impact of potential policies on the future cash flow generation of individual companies is highly challenging to predict. Short-term volatility can create opportunity and is likely the only thoughtful approach a long-term investor can utilize in relation to election-inspired price action today.
Tesla’s Stock Price is Up 55% Since the Election. Has Its Intrinsic Value Increased That Much?
Note: Performance is through 12/06/2024.
Source: FactSet
A cloudy crystal ball
Lastly, what have we learned this year that we can apply to our investment thinking in 2025 and beyond? Coming full circle on the first topic, it’s extraordinarily difficult to get the macro right. A few months ago, it looked highly likely (at least to me) that we were at the precipice of a significant rate cutting cycle. Today, my crystal ball on this front is increasingly cloudy, especially in light of the new administration’s potential policies and their ensuing impact on inflation. Additionally, who would have predicted the sudden toppling of the Assad regime in Syria after 14 years of civil war – and does anyone have the foresight to predict what comes next there?
Yet, as security analysts it’s vital to keep tabs on secular changes that have a direct impact on the quality of the underlying businesses in which we invest. We frequently talk about ‘quality’ as a key component of our investment philosophy, yet it is not an evergreen term when applied to a particular business. Changes in technology, consumer preferences and broad organizational behavior are “macro factors” to consider that can help a quality business move from good to great, or vice versa. The combination of a having a healthy humility regarding what’s unpredictable, keeping a keen eye on secular trends that can meaningfully influence individual security intrinsic value and maintaining a close mapping of company fundamentals is a balanced approach to aspire towards as we turn the page to 2025.
Happy holidays! And remember to never skip a Beat – Eric
Magnificent Seven stocks: Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia, and Tesla.
Source: FactSet®. FactSet is a registered trademark of FactSet Research Systems, Inc
Company information is sourced from each company’s earnings call.
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Consumer Price Index (CPI) measures the monthly change in prices paid by U.S. consumers.
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