investment insights
Equity markets should see further upside in 2024
Key takeaways
- We believe the narrative of resilient global growth and falling inflation has not changed, despite near term uncertainties. They should remain key tailwinds for equity markets in 2024
- We expect robust earnings growth across most stock markets for 2024. The first quarter reporting season gives us confidence that this could be a rare year with limited downgrade to consensus estimates
- We have reduced our tactical portfolio exposures to US equities given near-term pressures on US economic activity, and raised allocations to UK stocks, which offer an improved earnings outlook at a reasonable price
- In sectors, we continue to favour staples, energy, and communication services.
The outlook for global equity markets remains positive, with upside for most major indices, as the drivers of global growth and earnings broaden out. With the US stock market facing near-term pressures from slower economic activity, we tactically lower our portfolio exposure here to strategic levels and increase exposure to UK stocks.
Despite having seen its valuation temporarily decline in April, the US equity market – which makes up 65% of the MSCI World – still looks expensive. Its 12-month forward earnings ratio, a measure of future profits, is now one standard deviation above its historical average, while valuations of global equities are in line with 10-year averages. Yet valuation is just one component of our ‘four-pillar’ framework, which also assesses the macroeconomic picture, earnings trends, and technical factors such as market momentum, investor sentiment and positioning.
Valuation is important, but not the only return driver
Changes in valuation multiples, earnings growth and shareholder returns such as dividends and buybacks are the principal drivers of equity returns. This means that equity markets can continue to deliver positive returns when the valuation multiple stagnates, or even contracts, as long as the other engines are firing. Late 2017 was a good example. The S&P 500 index returned 7% in the 12 months following the end of October 2017, despite a starting valuation multiple that was more than two standard deviations above its 10-year average. The drivers: a robust recovery in earnings per share (EPS) and dividends.
Markets’ starting valuation multiple also has limited predictive power for near-term returns, even if the opposite is true over a 10-year horizon or longer. In other words, valuation is important, but not a reliable near-term performance indicator.
Earnings engine firing in 2024, underpinning upside
Global equities should see a boost from earnings growth this year. We expect earnings for the MSCI World to grow by high single digits in 2024, led by the information technology, communication services and consumer discretionary sectors. These sectors are supported by robust secular tailwinds, including geopolitical US-China competition, the rise in cloud services and the potential of artificial intelligence.
The cyclical recovery in global growth should provide further support. Economic growth revisions are rising outside the US, a reverse of 2023’s trend. While forecast EPS growth is still strongest in the US, Japan and Europe should also see robust expansion. We anticipate earnings growth of 11% in the US, 3% in Europe and 6% in the UK – consensus figures are 11%, 5% and 2% respectively. While downside risk remains, we believe 2024 could be a rare year where there is limited downside to consensus EPS. This occurred in 2016 and 2020, coinciding with a recovery in US manufacturing as measured by the ISM index.
The first quarter (Q1) reporting season supports our conviction, with better-than-expected corporate results in the US and Europe: almost 80% of US companies, and 50-60% of those in Europe, Japan and the UK beat EPS expectations. Profitability also surprised positively. Consensus earnings forecasts for 2024 and 2025 across most markets have risen. Semiconductors and consumer health were two strong themes from Q1 earnings. Semiconductor sales are a leading indicator for the global economy, given their omnipresence in the digital world, and we see a strong outlook for the industry1.
Assessing risks to US equities
Another recent trend was softness appearing in US consumption, with rising interest in better value products and services. But we do not think that US consumer health has deteriorated meaningfully. Real wage growth remains positive, albeit declining, and household debt to disposable income has normalised to pre-Global Financial Crisis levels. Some US banks released reserves in Q1, indicating that they see no sharp decline ahead. Visa’s Q1 payment volumes rose 8.5% year-on-year, in line with the previous quarter, indicating that spending patterns remained robust. We are closely watching credit card delinquencies, given the importance of the US consumer for the global economy and stock markets.
Recent US economic data has tended to surprise on the negative side when compared to other economies, and the UK in particular. Investor sentiment on the US market is also relatively extended, and we have reduced our tactical overweight exposure to US equities, bringing it in line with our strategic benchmark.
Another key risk is an extreme level of US equity market concentration, defined as the share of the 10 largest companies in the market capitalisation of the index (please read our Investment Strategy Bulletin for more). Whilst this trend should reverse, the timing is uncertain. Concentration was also extreme 12 months ago, and the S&P 500 has rallied 29% since. Portfolio diversification with exposures to attractively valued sectors and regions where performance has lagged is important at this stage.
Year-end targets
We use all four pillars of our framework – macroeconomics, valuations, earnings, and technical factors – to arrive at index forecasts, as well as base case, positive and negative scenarios. Our base case assumptions of robust EPS growth and stable valuation multiples in the US puts the MSCI US around 5,280 by end-2024, the MSCI EMU2 at 170 and the MSCI UK at 2,550.
Yet, we believe markets are pricing in a lot of good news, while more persistent inflation and fewer – or even no – US rate cuts this year remain a risk. Geopolitics and a heavy political calendar globally could also prompt volatility and weigh on sentiment.
Our sector preferences aim to offer portfolio diversification and include cyclical sectors such as communication services and energy, as well as some defensives such as consumer staples. Within regions, we prefer the UK market, based on an improving macroeconomic and earnings outlook. UK inflation is falling rapidly, and we forecast 100 basis points of monetary easing in 2024, while slower wage growth should help firms’ margins, and sterling weakening should help boost the FTSE100’s overseas earnings. We like the index’s sector exposures, which offer broad diversification, including energy, consumer staples, and miners. The UK also offers the most attractive valuation among developed markets and is still ‘under-owned’ by investors compared to other regions, according to recent surveys.
1 We believe the better-than-expected Q1 result from a US-based semiconductor giant carries a meaningful read-across, given that its chips and processors are everywhere and span multiple industries. Prior to Q1, the company had been reporting disappointing results for many quarters, consistent with ongoing de-stocking and a sub-par recovery in the manufacturing sector.
2 Economic and Monetary Union (EMU)
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