Favoring Stocks Over Bonds: A Rewarding Strategy in 2023
In 2023, investors who have favored stocks over bonds have seen their strategies pay off handsomely. U.S. equities have surged to new heights, defying the odds amid concerns about the tech sector’s investment in artificial intelligence (AI) and looming recession fears. Despite the volatility that these doubts have introduced, U.S. stocks have outperformed their global counterparts, buoyed by robust earnings growth and soaring valuations in the technology sector.
The Current Landscape of U.S. Stocks
While jitters about elevated valuations and uncertainties surrounding the upcoming U.S. elections can lead to market fluctuations, the outlook for U.S. stocks remains optimistic over the next six to twelve months. Analysts predict double-digit earnings growth in the coming year, alongside a potential decline in interest rates. This favorable macro backdrop encourages risk-taking, particularly in the U.S. market, where the Federal Reserve is expected to continue cutting rates despite resilient growth and a strong labor market.
Earnings strength is anticipated to broaden beyond the tech sector, which has dominated the headlines. For instance, earnings for a select group of leading companies—primarily tech-related—are projected to grow by 19% next year, a decrease from the approximately 30% growth seen in 2023. Meanwhile, the broader S&P 500 is expected to see earnings growth of 4% this year, with a more robust 14% anticipated in 2025, following a contraction last year, according to FactSet data.
Evolving Perspectives on AI Investment
The AI theme continues to capture investor interest, with significant potential for growth as its development is still in the nascent stages. However, skepticism about tech spending on AI persists. To address this, we have expanded our focus on AI beyond just the technology sector, identifying opportunities in utilities, energy, real estate, and industrials. Notably, U.S. utility earnings have surged by 8.2% over the past year—the fastest growth since 2020—partly fueled by the increasing energy demands of AI technologies. This sector is now competing closely with tech as one of the best-performing areas in the market.
Portfolio managers have observed that industrial companies involved in the AI buildout are experiencing heightened demand, further indicating that the influence of AI is spreading across various sectors.
Global Stock Picks: A Closer Look
Turning our gaze beyond U.S. borders, we maintain a positive outlook on Japanese stocks, although we have slightly reduced our overweight position due to the impact of a stronger yen on earnings. Japan’s solid wage growth, enhanced corporate pricing power, and shareholder-friendly reforms are all contributing to a favorable earnings landscape.
In Asia, there is renewed optimism for Chinese stocks, driven by expectations of significant fiscal stimulus that has halted recent earnings downgrades. While we have shifted to an overweight position in Chinese equities based on this policy signal, we remain cautious about the long-term structural challenges that persist in the region.
Conversely, our stance on euro area stocks remains underweight due to sluggish economic growth and a limited recovery trajectory. In the third quarter, earnings in the eurozone are projected to grow by a mere 3.7% year-over-year, with revenues still contracting. However, we see potential in specific sectors, particularly financials and healthcare. In healthcare, we are focusing on companies that stand to benefit from AI advancements and other significant structural shifts, favoring European firms over their U.S. counterparts due to a lower risk of revenue loss from expiring drug patents.
The Bottom Line on Market Strategy
As we enter the third quarter earnings season, our strategy remains clear: we are overweight on U.S. stocks, anticipating a strengthening of earnings across sectors beyond just technology. Our positive outlook extends to Japanese equities, while we continue to adopt a selective approach in the euro area, focusing on sectors with the potential for outperformance. The current market dynamics present a compelling case for investors to remain engaged and strategic in their stock selections.