The lingering risk of a global economic slowdown and doubts that AI stocks can continue their stellar gains are primary considerations for US equity investors in early 2024.

The rise of the Magnificent Seven technology stocks helped push the S&P 500 to a 24.2% return last year in US dollar terms after a disappointing 2022 in which it suffered a 19.4% loss. Without the seven tech mega caps, the index would have returned less than 10% in the 12 months to December 31.

The tech-dominated Nasdaq-100 Index did even better by recording its best annual performance (55.1%) since 1999 as the potential of AI became widely understood. 

The question now is whether the US will continue to record such impressive gains and, if so, whether its returns will remain concentrated in a handful of companies.

Beyond AI

“After four years, 2024 is lining up to be the year that the economy and individual behaviour have finally recovered and normalised,” says David Sekera, Chief US Market Strategist for Morningstar.

“While we forecast that the rate of economic growth will slow and stocks have already rallied and are nearing their highs, we still see multiple undervalued areas that provide relatively large margins of safety,” Sekera wrote on December 30.

The Magnificent Seven do not dominate Morningstar’s outlook for 2024, with Sekera arguing they have “run out of steam”. Instead, the research house predicts gains will be driven by a widening out of returns across the market; it sees the biggest opportunities in both value stocks and small companies.

It’s not alone in its cautious stance towards AI stocks. Fund manager Alliance Bernstein says the AI revolution will inevitably lead to greater competition between the mega-caps, which could affect profitability and that it’s too soon to identify the big winners of the AI revolution as the technology is just finding commercial applications.

REITs are back

Elsewhere, global fund manager Nuveen, has an overall neutral rating on international equities but does favour US stocks over other developed markets. It notes that US corporate earnings appear to be further along the road to recovery and that the US offers “better defensive characteristics in the face of a potential global economic slowdown”.

US real estate investment trusts (REITs) and public infrastructure equities also feature amongst the portfolio construction themes published by Nuveen’s Global Investment Committee.

“US REITs offer a combination of appealing traits for investors to consider. First, REITs have significantly lagged the broader equity market since the start of 2022. Importantly, however, REIT earnings have held up relatively well during the period, creating value for the market as a whole,” the committee says.

“Due to valuation compression, we’re slightly less positive toward US large caps than we were previously. Within this area, we’re focused on dividend growers and high quality growth areas, chiefly in technology sectors such as software and semiconductors,” according to Nuveen’s Chief Investment Officer Saira Malik.

Fidelity has a similar take on REITs, nominating shopping centre REITs, data centres and senior housing as among those worthy of consideration.

“Although the higher cost of borrowing was a headwind, many segments of REITs continued to show strong fundamentals and supply-demand dynamics in 2023”, the fund manager says.

Managing risk

A still uncertain world means advisers and their clients will have many risks to navigate in US equity markets as 2024 plays out. 

“For the year ahead, which sectors lead and which lag may depend in a large part on macroeconomic considerations, which are notoriously hard to predict,” Fidelity says.

“If the US decisively avoids a recession and achieves a soft landing, then cyclical sectors like materials, industrials, and consumer discretionary could take the lead.”

If a recession does eventuate, it nominates defensive sectors such as health care, utilities and consumer staples as among those that may come into favour.

Health care stocks are already on the radar of some investors after new weight loss drugs generated similar enthusiasm to the Magnificent Seven tech companies.

“The new-generation weight-loss drugs, namely Novo Nordisk's Ozempic and Wegovy, and Eli Lilly's Zepbound and Mounjaro, may transform how both diabetes and obesity are treated. Together, these two leaders in the space recently had a market capitalisation of nearly US$1 trillion dollars,” Fidelity says.

“However, investors may have underestimated how long it will take for these drugs to be broadly adopted.  This has created some interesting opportunities in areas of the market that underperformed on weight loss exuberance, including firms like Insulet, which makes insulin pumps, and Inspire Medical Systems, a maker of devices treating sleep apnea.”

Much like 2023, the year ahead will likely require US equity investors to have their wits about them, but there may be an opportunity for advisers to add value to diversified portfolios with prudent stock selection that balances potential reward with overarching risks.