What’s next for artificial intelligence (AI) and related technologies and how is that affecting your approach?
AI is likely to remain a key area of interest for investors, and we believe the obvious beneficiaries will continue to grow. The critical question is whether this growth will be sufficient to justify current valuations. Unfortunately, we don’t have a crystal ball, but market valuations are stretched. The top ten stocks in the US are trading on a price-to-earnings (P/E) ratio of over 49x, and the ‘magnificent seven’ technology companies represent over 20% of the global market capitalisation.1 In our view, this makes the AI winners vulnerable. With inflation likely to remain higher for longer, keeping bond yields and the discount rate elevated, there is a risk of a derating.
Outside of these market areas, our key focus is to avoid stocks that might be adversely affected by AI, while also identifying perceived losers that could potentially become winners. Additionally, the increased power demand driven by AI should benefit utilities and industrials, while there are segments of the semiconductor supply chain that we believe are attractive from a fundamental, valuation and yield perspective.
Do you believe the global economy is set for a hard or soft landing or a rebound?
The positioning of our Global Equity Income strategy, which is currently overweight consumer staples, utilities, health care and defensive financials, might suggest that we are predicting a hard landing. However, making economic predictions is not central to our investment process, and our multidimensional research, which focuses on long-term themes, fundamentals and stock valuations, indicates that stocks that will benefit from slower economic growth continue to trade at attractive valuations. We would also note that the valuations of stocks listed outside the US have continued to grow more attractive on a relative basis following the US election. This presents a range of opportunities, some defensive and others more cyclical.
Do you believe inflation is likely to tick up again? Should this be a worry for investors?
From a macro perspective, the key theme is ‘great power competition’, which refers to the battle between liberal democracies and autocracies. This competition is encouraging greater localization of manufacturing and protectionism, increased defense spending, rising wages and greater resource nationalization. The upshot is a more inflationary world.
The impact of President-elect Trump’s second administration is difficult to assess, given that we don’t know exactly what policies he will implement. However, the thrust of his agenda does little to change the great power competition backdrop. As a result, we expect a continuation of the ‘higher-for-longer’ inflationary environment.
Predicting where interest rates ultimately settle is challenging, but we can be confident that they will not return to the levels seen following the 2008 global financial crisis. This should not necessarily worry investors. However, the combination of a higher discount rate as a result of higher bond yields and the valuation of growth stocks could well lead to a change in market leadership, similar to that which occurred following the bursting of the last Nasdaq bubble in the late 1990s.
Reassuringly, we believe income stocks are currently inexpensive. As we return to a more normal interest-rate environment, we anticipate a return to a market where the compounding of dividends is once again key to equity-market returns.
How do you think geopolitical issues will play out for investments in 2025?
We expect geopolitical uncertainty to continue to be a big feature of markets and economies in 2025. While we don’t have the same number of elections in the coming year as we have seen in 2024, the results of 2024’s elections will continue to play out. As previously discussed, geopolitics is a key factor in our view that inflation will remain higher for longer. Tariffs, both those applied by the US and in response to it, localization of manufacturing in response to China’s threat to Taiwan, and resource nationalization resulting from international conflict, are all likely to contribute to a more inflationary world.
Where do you currently find the most interesting opportunities?
On a relative basis, we believe that the most interesting opportunities from a regional perspective are across Europe and Asia. Sector-wise, we see the best opportunities in consumer staples, utilities, health care and defensive financials, including insurance companies and exchanges. We are also increasingly seeing opportunities in short cycle and thematic industrials, as well as in specific areas of commodities.
Sources:
1 FactSet, 11/30/24, FTSE World Index
Authors
Jon Bell
Portfolio manager, Equity Income team
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