Seven key themes to better understand today’s stock markets

The key questions for the remainder of 2024 would appear to be whether a soft landing for the global economy is in the bag and what this means for interest rates given the usual “long and variable” lags.

However, the focus on the US Federal Reserve (Fed), and politics, this year may be misplaced. Instead, we think it’s better to concentrate on what we observe today to be the most attractive long-term opportunities, rather than falling into the trap of thinking we can call the economy and translate this into market timing.

We outline below some of the key themes for the year. The full version of this article is available here.

Theme 1: Recession avoided, but does it matter?

If the Fed does keep rates on a plateau for longer than expected, history suggests that after an initial bout of enthusiasm, caution gradually returns even as the timing of the first rate cut approaches. This would advocate risk-off positioning favouring high quality leadership, which is likely to be broader than the usual focus on defensives. The big question is how long the plateau in the Fed funds rate will last.

However, if rate cuts are just around the corner, it’s not clear that policy easing is good for equities, typically because the lagged impact of prior tightening eventually weighs on earnings and equity returns.

On balance, we think this year could be rotational and more volatile with less support from broader market returns. If so, it will be more about stock selection but the backdrop favours high quality stocks alongside broader participation, particularly further down the size spectrum.

Theme 2: Longer term: valuations are not compelling for indices, particularly the US

Valuations are the best guide we have when speculating about longer term trends. The S&P500 started this year at around 21 times forward earnings, a near 20% premium to its 15-year median. Our preference is to use the Cyclically Adjusted Price Earnings multiple (CAPE) for longer term analysis which averages earnings over the past decade. Lower CAPEs have historically been strongly associated with higher subsequent 10-year returns (and vice versa).

On this basis, the current CAPE in the US (31x) is 22% higher than its post-1990 average. This clearly suggests that future returns will be lower. The bar is much lower for equities elsewhere, simply because the average CAPE for the rest of the world (15x) is at a slight discount to its recent history.

Theme 3: Will the "Magnificent Seven" continue to dominate performance?

Market commentators tend to think about the Magnificent Seven as a cohort given significant index representation, underlying technology trends and since they have largely dominated equity performance for the last six years.

Whilst their interconnectedness is more nuanced, they do all share a common trait of being leaders in their respective fields and have strong business franchises in fast growing areas.

It seems wise to monitor their performance on a case-by-case basis like a hawk, particularly from the perspective of ensuring earnings continue to support their recent momentum.

Theme 4: Tech Déjà Vu?

2024 began with the US tech sector accounting for as much of the US broad market index as it did at the height of the bubble peak in mid-2000. In other words, tech holds a significant sway, accounting for a sizable chunk of the market (23% of MSCI World and almost 29% of the S&P500).

This raises a critical concern: if the US tech sector stumbles, could it drag the entire market down with it? This time things are different, most notably the sector has much stronger fundamentals compared to 25 years ago, but the outsized influence of US tech on the market is worth watching closely.

Theme 5: Dispersion of valuation is high indicating an abundance of opportunities

Rather than timing sectors, we believe there is great potential to add value within equities simply because of the current high level of dispersion across the market.

Given the breadth of opportunity, a few trades that we would highlight include:

• Quality (and defensives) to make a comeback
• Small caps look attractive
• The value opportunity is broad based – quality at a reasonable price is the sweet spot
• Emerging markets could be a diversifier

Theme 6: Geopolitics – a year of national elections

Equity markets have proved remarkably resilient to geopolitical tensions over the past two years. We would be careful in extrapolating the sanguine response of the equity market in recent years to geopolitical shocks, particularly against a potentially less supportive economic backdrop.

Theme 7: Short term ESG fatigue should not overshadow the longer term trend

After a difficult year for sustainability focused investors in 2022, last year was less hostile thanks to the weaker performance of energy stocks. However, a general fatigue with ESG investing is increasingly evident in the slower pace of investor flows and growing regulatory burdens.

We expect the trend towards more engagement led strategies to continue as well as a broadening out of the focus on decarbonisation to wider environmental issues such as biodiversity.

ESG is an evolving area but we remain firmly committed to providing clients with a range of potential solutions in what we have always regarded as a client led discussion.

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