Four stock investing insights for 2024

What’s in store for stocks after they climbed a wall of worry to exceed expectations in 2023? Fundamental Equities Global CIO Tony DeSpirito sees a rich hunting ground for stock pickers and offers four insights for 2024 ― from sector likes to international opportunities.

BlackRock’s Tony DeSpirito recently appeared on The Bid podcast with a “Stock Picker’s Guide to 2024.” Some of his key reflections after nearly 30 years as an active investor: “Expect the unexpected” and “stay invested.” 2023 offered a case study in both, with cash-heavy investors forgoing some attractive return in stocks.

Here we offer highlights of the broader conversation with four insights for 2024.

1. Interest rates, inflation and recession remain key topics headed into 2024. What is your view on these?

We’re not macro forecasters in Fundamental Equities. We’re bottom-up stock pickers. We’re looking for good businesses at good prices that we want to own for the next three to five years. That said, it’s important to recognize where we are in the cycle.

I’d say we’re still in the late innings of the economic cycle. That doesn’t mean I’m forecasting a recession or preparing for recession. It just means we’re in the later stages: Employment is rather full, there’s not a lot of slack in the economy, and the Fed’s job is a tough one, to be quite honest. If the Fed tightens too much or for too long, we risk a recession. If the Fed tightens too little or rolls back some of those increases too quickly, we risk inflation coming back. So we’re at that point in the cycle when you have to pull out your late-cycle playbook as an investor.

That means you want to go up the scale in quality, focusing on good businesses with strong balance sheets. (We discuss the appeal of quality and its tendency to outperform after the end of Fed rate hikes in our Q1 market outlook.) And you want to buy at fair valuations. As you do that, the implication for investors is that you’ll be relatively okay no matter what the macro environment offers. I think that was the lesson from 2023.

2. Does this require greater selectivity in 2024?

I see selectivity as a multi-year issue. We’ve talked a lot about this being a new era of investing. What we really mean is that we’re going back to old eras. The period from the Global Financial Crisis (2008) through to the end of 2021 was incredibly unique by any historical standards. It was a period that was characterized by excess supply ― too many empty houses, too many unemployed people, too many goods coming from all over the world ― and not enough demand to soak it up. The Fed’s job was to fight deflation, to constantly come to the rescue with low interest rates, quantitative easing, etc. The result of all that was outsized equity returns. Particularly in the U.S., average annual equity returns were about double historical averages for that entire period.

Not only were equity returns high, but volatility was low versus history. So, it was a proverbial free lunch ― better returns at slightly better volatility. That meant you really needed to make one decision: Buy the S&P 500 in the low-cost way and forget it.

We’re in a different environment now. It’s no longer excess supply; it’s not enough supply. Some of that is demographics ― the baby boomers are retiring and that’s having an impact. Some of it is the massive transition with decarbonization. Eventually that will help on the cost side, but there’s going to be a number of years where we’re spending a lot of money to fund the transition, and that’s inflationary.

And finally, we’ve reached peak globalization. Now we’re in a period of rethinking supply chains. That too means higher costs, more inflation. And so, the Fed’s battle is going to be dramatically different going forward. It’s going to be about fighting inflation instead of deflation. Inflation will come and go, but the fight will be ongoing. We believe that means more stock volatility. This is a good environment for stock pickers for two reasons:

1) Market returns are going to be more normalized. That means alpha is going to be a more important part of portfolios. The search for excess returns requires active managers.

2) If you’re a skilled stock picker, volatility is your friend. We all know alpha’s a zero-sum game. But if you’re skilled in a volatile environment, you can do better than average.

3. What sectors interest you for 2024?

We continue to like healthcare. First of all, long-term demand is solid. That goes back to demographics. We’re aging as a society, and as you get older, you consume more healthcare. It’s a sector with a lot of innovation and a lot of high-quality companies. It’s also a resilient sector. You don’t stop getting sick or going to the doctor just because we’re in a recession. Despite these favorable characteristics, healthcare valuations are quite attractive, with lower multiples than the average stock in the S&P 500. There are winners and losers in the healthcare sector. So, I think it’s not only a good sector to own overall, but it’s also a very good sector for stock pickers.

The tech sector is another area where there’s a lot of dispersion, a lot of opportunity for stock selection. And I think artificial intelligence is going to be the topic for the next 20 years. It’s one of the biggest things going on, just like the internet and the smartphone were over the last 20 years. But I don’t think this is going to be an area where you want to set it and forget it. The opportunity is evolving and an active approach will be critical.

4. Where do you see investment opportunities outside the U.S.?

Japan is an interesting market. Valuations are fairly attractive, but what’s really interesting about Japan is profitability. Japanese companies have been less profitable than their developed market peers around the world. Part of that is because of the deflationary spiral they’ve been in, and that looks like it’s getting resolved. Part of it is company will, and what we’re seeing is both governments and stock exchanges there putting a lot of pressure on companies to become more efficient. We’re starting to see companies get away from the conglomerate structure and deploy cash that’s been sitting on their balance sheets not earning a lot. So we’re starting to see that return on equity (ROE) increase, making these companies more profitable. That’s where the opportunity is.

As I look elsewhere across the globe, two big themes emerge. One is in energy, where I see a big valuation dislocation. The U.S. integrated oil companies are much more highly valued than the European and UK integrated oil companies, despite the underlying businesses being quite similar. And over the last couple of years, the Europeans have become much better capital allocators than they were historically. So, that’s a valuation opportunity to exploit. That valuation gap started to close in 2023, but I think it has a long way to go.

Another gap is a quality gap. When I look at U.S. versus European pharmaceutical companies, for example, they’re similarly valued but the Europeans have higher quality, particularly when it comes to patent expirations. The large U.S. pharmaceutical companies have a number of upcoming patent expirations. That’s a lot less true in Europe, where the R&D pipeline is also more robust. Healthcare was not a great sector in 2023, but we avoided the value traps of U.S. large-cap pharmaceuticals, looking instead to some of the obesity drugs, medical devices and some European pharmaceuticals. So again, very much about stock selection.

Final thoughts for the new year?

We have an expression around here: It's about time in the market, not timing the market. If nothing else, 2023 is a great example of that. I think a lot of people thought it would be a great year to sit things out. Turned out to be a horrible time to sit things out and not be in the market.

And then, I think the best advice is to participate in the market but do so in a prudent way. Don't do it in a speculative way. The more prudent, the more resilient your portfolio is, the more likely you are to stick with it. And that's the key ― get rich slowly, not fast.