by Carrie King, CIO of U.S. and Developed Markets, BlackRock Fundamental Equities
Artificial intelligence (AI) and its unparalleled potential have powered stock market returns over the past year. Yet the market has more to offer, particularly as leadership may be poised to broaden beyond AI beneficiaries. Equity investor Carrie King shines a light into forgotten corners of the U.S. equity market to reveal what may be some underappreciated sources of return.
U.S. stock market returns and earnings growth have been powered by a small group of mega-cap standouts, with their leverage into artificial intelligence (AI) contributing heavily to the surge. But what are investors missing as indexes and mindshare are centered on the mega trend? Carrie King, U.S. and Developed Markets CIO for BlackRock Fundamental Equities, joined The Bid podcast to peer into some of the less visible corners of the stock market as AI has commanded the spotlight.
Prepare for ‘handoff’
While the leading mega-cap tech and internet stocks dubbed the “Magnificent 7” have driven stock market returns over the past 12 months, many also had experienced a big fundamental setback in 2022. So the AI-fueled rush in 2023 included a fair bit of reversion from the prior year. Year-over-year earnings comparisons were easy as a result, and the earnings growth for many large tech stocks may have seen their high bar now.
Going forward, Ms. King sees growth rates for these companies normalizing, leaving room for other parts of the market to catch up and providing for greater market breadth.
“This handoff reflects a tech-specific business cycle that has been out of sync with the rest of the market,” she says, explaining that technology soared as life went online during COVID, then declined after companies overspent and interest rates climbed, and resurged with rightsizing and the AI infusion in 2023.
Other areas of the economy, such as parts of healthcare and consumers, had the opposite experience: Suffering amid COVID shutdowns and still readjusting upward today. “Hip and knee replacements that were delayed during the pandemic are back on. And consumers are still playing catch-up on missed travel and experiences,” she says.
Ms. King sees the market broadening as both cycles advance ― and normalize ― setting up more of a “head-to-head race” in terms of earnings growth prospects. This, she believes, could create exciting stock-picking opportunities.
Two areas to watch
Where to look beyond AI? Ms. King and the broader Fundamental Equities platform are seeing value in healthcare and industrials.
In healthcare, negative earnings growth in 2023 could approach a positive 10% in 2024 and even higher in 2025, according to the team’s analysis.* Healthcare offers both defensive characteristics and growth momentum from innovation.
On the defensive side, healthcare is a necessity, so spending tends to be stable no matter the economic backdrop. It also benefits from a secular trend in aging populations, which means more healthcare needs and more healthcare spend. At the same time, innovations like the GLP-1 diabetes and weight loss drugs are one example of the fast progress happening across the industry. Yet, Ms. King notes, the sector is trading below the S&P 500 average and its own long-term valuation.
She cites opportunity in medical devices, an area still coming back from the pandemic-induced slowdown, and points to names that over-earned during COVID, such as life science tool companies that went up, then down and are now resuming an uptrend.
Ms. King notes a preference for pharmaceuticals in Europe versus the U.S. where patent expirations are a threat. The major U.S. drug makers have a significant share of their revenue coming off patent in the next three to five years, which could mean steep revenue declines. For this reason, she says, active selection is key. Because 40%-50% of the U.S. healthcare sector (based on Russell indices) is made up of pharmaceutical and biotech companies, the indexes are heavily exposed to this risk.
She also looks to stocks in growth areas such as the GLP-1s, as well as hospitals and drug distributors, which she explains do well when drugs come off patent because they can distribute generics and at higher volumes.
In industrials, Ms. King sees potential for increased capex spend for several reasons: catch-up from years of deferred infrastructure upgrades; a reshoring trend that could see companies relocating their operations closer to home; global decarbonization efforts that will require the build-out of new eco-friendly systems, along with government programs that earmark funding to advance those efforts; and increased interest in automation as a shrinking working-age population makes the case for industrial and technological automation of processes.
Addressing the elephant
Of course, there’s no ignoring AI and it’s great investment potential. Ms. King notes that a platform-wide overweight to semiconductors, “the picks and shovels way to invest in AI,” has performed well. The teams are now evolving their thinking.
We’ve developed a greater appreciation for data, she says. “Data feeds the AI models, so we expect investors will ascribe more value to companies that own, sell and store data,” she says. Examples are market data and intelligence providers or companies involved in financial information and analysis.
The investment opportunities in AI are going to evolve as the technology itself advances and as new business models are born. This, she says, makes AI another area that requires active management and skilled stock selection to really capitalize on the change and reap the greatest benefits.
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