MICHELE SANTANGELO: Continued volatility offers investors lucrative equity risk premiums

As we reflect on 2023’s stock market performance we also identify sectors and themes that are likely to dominate in the year ahead. Last year unfolded amid geopolitical tensions, economic uncertainty and rising interest rates. Despite these challenges, the year produced the “magnificent seven” — the incredible performance of Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla.

The surge of artificial intelligence (AI) and related ventures propelled the share prices of technology stocks. Nvidia was the poster child of the AI boom, rallying by more than a staggering 200% in 2023.

One of the biggest stories of 2023 was the medical sector. The popularity and efficacy of the obesity-fighting drugs launched by Novo Nordisk and Eli Lilly have driven their share prices to record highs. The success of these obesity drugs has led investors to infer that healthier people will require less medical care, medication and surgeries, which has played out in the medical device, biotechnology and pharmaceutical space. 

The rising interest rate environment produced many casualties. Long-dated bonds continued their bear market descent while interest rate-sensitive sectors also suffered. Real estate was a significant loser as rising interest rates dampened investor sentiment.

Clean energy was one of the more surprising casualties. Many clean energy leaders, such as Enphase and SolarEdge, saw their share prices fall by more than 70%. The weight of higher interest rates dampened consumer demand for solar energy while also increasing the cost of funding.

Amid the challenges, uranium emerged as a clear winner in the energy sector, rallying more than 70% for the year. It is the fuel used in nuclear power plants and is gaining further acceptance as a clean energy source that can produce stable base load power at scale. Many countries continue to build plans for more nuclear power. China now has 26 nuclear reactors under construction in addition to its enormous wind and solar projects.

War and geopolitics also grabbed headlines as conflict in the Middle East escalated. The increase in oil prices was temporary, but cybersecurity firms took another sharp step higher after a tremendous rally at the beginning of the year. Many fast-growing cybersecurity firms, such as CrowdStrike and ZScaler, doubled their share prices from a low base in 2022.

Valuations across fintech derated quickly from their lofty levels. PayPal, Block and Adyen are major players in the fintech space that have experienced significant falls. But Mastercard and Visa remain steadfast as the oligopoly of the payment processing world.

Crypto market

As an extension to the fintech theme the crypto market came out of a “crypto winter” in 2023, with the largest cryptocurrency, bitcoin, moving up 150%.

Global markets have had diverse equity market performances. The US led developed markets, followed by the EU. At the same time, the Japanese market stood out as the yen continued to weaken and investor sentiment towards Japanese companies improved on company reforms.

Emerging markets showed the most significant performance dispersion. Chinese equities were some of the weakest in the world despite early optimism around their Covid reopening. The Chinese property market woes have significantly weighed on the economy and sentiment coupled with further technology trading curbs implemented by the US. Unfortunately, SA equities did not fare too well either, weighed down by record load-shedding and economic stagnation.

Emerging markets did have many winners, including Mexico, now the US’s largest trading partner at China’s expense. Brazil also produced a strong performance, as did India.

Market consensus indicates that the interest rate cycle has peaked. Our macro-positioning for 2024 is underpinned by slowing global economic growth that will help ease inflation. This slowdown in growth will free up central banks to cut interest rates.

At a thematic and sector level, we foresee several areas poised to add alpha to portfolios:

• Biotechnology will be a major beneficiary of declining interest rates. This macro support and significant cash holdings relative to market capitalisations provide a strong combination for sector gains. 
• Technology companies should extend their share price gains after a strong year as earnings and profit margins are forecast to continue to rise. 
• Luxury goods companies have performed well since 2020, but moderating expectations have seen many companies trade well off their share price highs. 
• Cloud and AI companies should continue to perform well as spending accelerates across industries implementing cloud and AI programs. 
• Real estate has been under significant pressure for several years, but there are opportunities in the sector as suppressed valuations and an improved interest rate outlook become tailwinds.
• Clean energy has started to rebound from its lows and is a sector with structural tailwinds. Declining interest rates will boost the sector as projected internal rates of return become more attractive. 
• Private equity and alternative asset managers are well positioned with significant deployable capital and strong fundraising programmes. 
• Fintech is a sector that has gone from market darling to pariah over the past two years, but valuations are now more attractive. 
• Small capitalisation shares have underperformed dramatically globally but have seen a mild uptick as the central banks take a dovish stance. 
• Special situations continually occur in financial markets irrespective of macroeconomic conditions, and we anticipate 2024 will be no different. Pershing Square is a great example, as the listed hedge fund trades at a greater than 30% discount to net asset value and continues to generate strong returns.

There will undoubtedly be volatility in equity markets in 2024, but this is nothing new. Volatility allows equity investors to earn a lucrative equity risk premium. We remain steadfast in our long-term support for equities for building long-term wealth, notwithstanding any challenges.

• Santangelo is a portfolio manager at Independent Securities.