Technology’s Magnificent Seven captures investors’ attention, along with the wider AI boom. Piyasi Mitra speaks with fund managers navigating global equities, where a big focus is on balance sheets and AI innovation.
Global equity managers are keeping an eye on leverage at the companies they invest in. This is a result of an equity market contending with higher interest rates.
“While leveraged businesses face the risk of a rising debt burden, those with net cash balances will start to see a better return on that balance sheet strength,”
“While leveraged businesses face the risk of a rising debt burden, those with net cash balances will start to see a better return on that balance sheet strength,” says Damon Ficklin, a portfolio manager who heads the large company growth team at asset manager Polen Capital. This is also a market where companies with good brands and in-demand services will reign, owing to strong pricing power throughout economic conditions characterised by higher inflation.
Companies with strong balance sheets can also invest to drive growth and acquire weaker competitors on more favourable terms, he adds.
Mikhail Zverev, fund manager of the Edinburgh-based Amati Global Investors’ Amati Global Innovation Fund, concurs. “In a non-zero interest rate environment, balance sheet strength and the ability to fund their growth through internal earnings and cash flows will be ever more important.”
But many global equity managers cannot ignore the power of the “Magnificent Seven” – the seven leading tech stocks that include Microsoft and Meta – and the rise of AI. At one point in February, these stocks were not only accounting for about half of the gains in the S&P 500 but also contributed to over a quarter of the index’s total market capitalisation.
Ficklin notes the link with AI. Businesses like Microsoft – and others beyond the key seven tech players, such as Adobe, ServiceNow and Workday – are already benefiting from customers moving to the cloud, and such trends will only be reinforced by the needs of companies to organise their data to deploy AI within their business, says Ficklin.
With the arrival of AI, cybersecurity has also reached a new prominence. The burgeoning rise of generative AI is allowing hackers to deploy more sophisticated attacks. US technology company Fastly’s recent cybersecurity survey reveals a notable impact of cyberattacks on global businesses, with an average sales loss of 10% in the past year. This has prompted companies to bolster their defences, which in turn has benefitted the share prices of cybersecurity firms like Palo Alto, Crowdstrike and Check Point Software. According to Zverev, as the initial AI excitement subsides for companies like Nvidia and Microsoft, investors are turning to the cybersecurity sector for the next wave of opportunities.
Daniel Casali, chief investment strategist at wealth management group Evelyn Partners, notes that in 2023, the Magnificent Seven – who are Apple, Microsoft, Alphabet, Amazon, Nvidia, Meta Platforms and Tesla – returned an incredible 107%, far outpacing the broader MSCI USA index, which delivered a relatively subdued but still healthy 27%.
Watching US/Europe divergence
For Zverev, the disparity of returns between the MSCI Europe (up 4% year to date at the time of writing), compared to the global benchmark (up 8.6%) is due to the seven leading tech stocks, which boosted the global market. The NYSE FANG+ index offering exposure to a select group of highly traded growth stocks of next-generation technology and tech-enabled companies is up 81%, he adds.
“Some of this is down to fundamentals. But some of it is valuation expansion, boosted by the perceived benefit of generative AI and by big tech stocks becoming viewed as safe havens, in the same way that stocks like Procter & Gamble and Nestle were once viewed,”
“Some of this is down to fundamentals. But some of it is valuation expansion, boosted by the perceived benefit of generative AI and by big tech stocks becoming viewed as safe havens, in the same way that stocks like Procter & Gamble and Nestle were once viewed,” says Zverev at Amati GI.
However, Casali at Evelyn Partners highlights a threat to AI-led companies from regulators, citing Meta’s ongoing lawsuits and the EU’s plans to regulate tech giants and he says that despite the stellar performance of AI-led stocks, investors might overlook other opportunities beyond the Magnificent Seven stocks if they solely focus on these companies.
A divergence in the European market is evident through the fortunes of Europe’s big tech flagship – the Dutch ASML, which is part of the microchip supply chain. Its stock was up 23%, whilst Novo Nordisk, a diabetes pharma supplier whose products are expanding into obesity treatment, was up 50%.
Other industries where Europe excels – consumer and luxury goods – lagged. Zverev says this was down to “Western belt-tightening” and delays in the Chinese recovery, which have compounded turbulence in the Chinese property market. Some leading staples and luxury stocks are down year-to-date, in some cases substantially, Zverev adds.
Contrasting global markets against European markets has gained relevance today for fund managers. This is because there was significant divergence in performance across geographies and sectors in 2023, says James Harries, senior fund manager at investment boutique Troy Asset Management.
“Whereas the US has returned 10.1%, Europe has only managed 1.6%. Similarly, whereas the MSCI High Dividend Yield Index has returned -1.0%%, the broader, more tech-heavy MSCI World Index has returned 12.0% in sterling.”
Europe’s underperformance presents attractive investment opportunities, such as enhancing portfolio quality and or pursuing growth while maintaining income. Consequently, Harries expects capital allocation to Europe to rise in the coming months.
The divergence extends to sectors. In high dividend yield indices, materials, financials and consumer discretionary lead, which in turn signals a recovering economy, says Harries.
Technology and communication services – particularly AI-related – have excelled in broader indices. For instance, top performers in the Trojan Global Income portfolio include RELX and Microsoft – both considered AI beneficiaries – along with the recovery of Admiral, an insurer, from Covid challenges. Harries says that in anticipation of potential market challenges due to a slowing economy and full valuations in the US, defensive positioning in the portfolio could be advantageous.
With a focus on innovation, specifically in technology, healthcare and industrial sectors, opportunities for value creation exist in areas where the market has yet to fully recognise innovation. For Zverev, one such area is bioprocessing – tools, consumables and services to pharma companies developing next-generation therapies. According to Zverev, numbers and volumes of new biologic drugs are a clear growth driver, despite near-term excess inventory overhang and spending cuts by smaller biotech clients.
The logistics sector is embracing automation to address rising wage costs and labour shortages. With warehouse automation valued at $30 billion and 80% of warehouses still manual, there’s an opportunity for growth, he points out.
A popular equity sector still in growth mode is semiconductors. The market is expected to double to US$1 trillion by 2030, highlights Zverev. Semi-conductors are seen as a shadow AI place, and Zverev adds that evolving technology – such as miniature chip features, new materials and new packaging techniques – will accelerate demand for specialist equipment.
Large equipment stocks (ASML, Applied Materials and Tokyo Electron) are up; specialist companies in areas such as atomic layer deposition or advanced packaging have done even better, says Zverev.
An expected cyclical post-Covid slowdown in capital investment was offset by three factors: increased spending by China in developing its domestic industry, government funding – like the Chips Act – boosting investor enthusiasm, and the AI boom that benefitted semiconductor equipment. However, this exuberance might be temporary, offering the possibility of another opportunity, says Zverev.
The road ahead
Vincent Mortier, group chief investment officer at Amundi, foresees a subdued global economic outlook in 2024, contingent on containing the Middle East crisis. The slowdown in developed markets is the primary driver. Mortier foresees a potential US recession in the first half, driven by tightened financial conditions impacting consumer spending and business confidence. He notes that Eurozone growth remains slightly positive, buoyed by robust household disposable income. “The key factors for global equities include monitoring the interplay of growth, inflation and central banks’ responses to these economic dynamics,” he adds.
In the first half of 2024, investors should prioritise defensiveness and quality value in equities, he says.
“Concentration risk is high as US equity market upside has been driven by just a few names. Entering 2024, we favour value in the US, Japan and sustainable dividends globally.
“Concentration risk is high as US equity market upside has been driven by just a few names. Entering 2024, we favour value in the US, Japan and sustainable dividends globally.
“Later, in the second half of the year – and when the easing cycle starts – move towards more cyclical markets and sectors, such as Europe. The energy transition, healthcare, capital allocation and artificial intelligence will be themes to watch in equities.
For long-term structural themes, energy transition remains the top focus in ESG. “In equities, we are focusing on the decarbonisation of buildings, food waste reduction, sustainable farming and technologies that can boost the transition. Infrastructure linked to the energy transition should also benefit from government support,” says Mortier.
