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Growth Stocks

Unanswered Questions Could Be Major Source of Volatility in 2024

Throughout 2023, investors confronted uncertainty. Will the Fed tame inflation? Will rate hikes cause a recession? Will the economy experience a hard or soft landing? Will corporate earnings rebound? Will the rally broaden beyond the Magnificent 7 tech stocks? You can probably add some of your own to the list.

The Fed Isn’t in a Hurry to Pivot to Rate Cuts

Unfortunately, many of these questions remain unresolved and will continue to overhang the market in 2024. We can agree that the Fed appears to have broken the back of inflation. But the success of its rate-hiking campaign has given rise to another conundrum. When and how aggressively will the central bank transition to rate cuts?

In our view, the slowdown in inflation is a clear positive for the economy and stocks. But we don’t believe inflation has fallen far enough for the Fed to completely back off, either. Over and over, Fed governors have made it clear that rates will stay higher for longer, and that they will move more slowly than many market participants hope. That’s likely to be an ongoing source of tension in 2024.

The Fed can afford to keep rates high because the labor market has been so resilient. A strong job market is crucial support for a soft-landing or even a no-landing scenario.

The outlook for earnings growth is less optimistic. Given the risk of recession, we think double-digit 2024 earnings estimates are high. These forecasts likely reflect either easy prior-year comparisons or overly optimistic expectations. It’s important to note that even if we take those aggressive forecasts at face value, the Russell 1000® Growth Index remains expensive relative to the S&P 500® Index. In addition, growth stocks are rich relative to value stocks compared with their relationship over the last two decades.

Moreover, the fact that the very largest stocks have performed so well for an extended period has resulted in historically extreme concentration in market-cap-weighted indexes. For example, the top 10 stocks in the Russell 1000® Growth Index account for more than half of its total market capitalization.

In the past, index concentration has been mean reverting; that is, markets don’t tend to stay this concentrated for long periods. For example, one recent study by a Wall Street research firm showed that in past periods of extreme concentration, equal-weighted measures of index performance outperformed the concentrated market-cap-weighted versions over the next six- and 12-month horizons.

What’s more, narrow leadership has also historically been associated with poor performance by the broad cap-weighted index for the following 12-month periods.

There’s More to Growth Investing Than the Magnificent 7

There’s no guarantee these trends will reverse in 2024, but it’s pretty clear to us that stocks face many uncertainties. And, while we believe market volatility is likely, we’re not advocating for shorting the market or avoiding growth stocks entirely. Rather, we think it makes sense to take a more diversified approach by sector and size rather than heavily concentrating in the very largest tech firms.

We’re taking the opportunity to increase diversification by opportunistically adding companies we might have passed over previously or adding back high-growth companies that have underperformed. We have also been reducing or eliminating holdings that we think have relatively limited appreciation potential. We’re allocating the capital from these sales into higher-quality, secular growth companies we have been monitoring for better valuations.

Another reason not to abandon growth stocks is that our analysis shows that growth has tended to hold up relatively well in recessions. This really shouldn’t be too surprising. We expect high-quality, competitively advantaged companies producing durable earnings growth to be attractive during economic downturns.

Keith Lee, CFA
Keith Lee, CFA

Co-Chief Investment Officer

Global Growth Equity

Value Stocks

Health Care Is a Potential Bright Spot in a Shaky Economy

While everyday life settles into a post-pandemic normal, some industries, like health care, continue recovering.

Census data shows hospital discharges are still below pre-COVID levels. It’s one of several measures that show some areas of health care utilization remain lower today than before 2019.

With COVID now posing less concern, pent-up demand for elective procedures has helped normalize health care utilization. Labor shortages in the industry have mostly improved, and we expect that trend to continue into 2024.

That should be good news for medical technology companies, device makers and laboratories that have waited for a tailwind since COVID disrupted their businesses.

These disruptions and new ones, like the market’s reaction to weight loss drugs, have pushed several health care stocks to attractive valuations. This helps make the sector a potential bright spot in an increasingly unpredictable and precarious economy.

The Impact of Interest Rates in 2024

A year ago, many economic forecasters penciled in a recession by the third quarter of 2023. When that didn’t happen, their focus turned to a potential soft landing.

While a soft landing is possible, we think the economic landscape shows several red flags linked to tightening monetary policy.

Higher interest rates have pushed 30-year fixed mortgage rates up to 7.5%, the highest level since 2000. This should weaken housing affordability and homeownership even more.1

There’s evidence that higher rates caused businesses to reconsider their spending. In August, a Federal Reserve (Fed) survey found that 80% of responding companies said current rates affected their capital expenditure plans.2

In November, Fed Governor Michelle Bowman said the effects of monetary tightening on the economy remain to be seen.3 We tend to agree, as rate hiking can reveal its fruits, ripe or rotten, a year or so after taking effect.

Tracking Economic Signals: Credit Conditions Indicate Potential Concerns

Credit conditions will help inform us about the economy’s direction. Credit quality normalized throughout much of 2023 after an extended period of strength. Signs point to a deterioration in credit quality and availability into early 2024.4

Auto loan and credit card delinquencies have surpassed pre-pandemic levels.5 A Fed loan officers survey in October revealed tighter standards and weakening demand for loans to commercial, industrial and commercial real estate firms.6

Relatedly, we will watch what happens to margins for businesses that took out loans years ago at near-zero interest rates as these firms begin to refinance at higher rates.

Interest Rate Impact on Industrials

Industrials offer another economic signpost. Short-cycle industrial demand — orders for inventory that can be made and delivered quickly — declined over the last 12 months.

Buyers of short-cycle products like agricultural and construction equipment will pay more due to higher rates if they finance the purchases. We have already seen forecasts showing fewer deliveries for this equipment in 2024.

Turning to long-cycle industrials in 2024 — orders for products placed months or years ahead — it’s too soon to know how this segment of industrials will fare, but leading indicators have flashed warning signs. For example, the Architectural Billings Index, an indicator of nonresidential construction activity, fell significantly in September, suggesting a slowdown in construction activity.7

So-called megaprojects are another segment of industrials to watch. These projects worth $1 billion or more — often in the realm of manufacturing plants for semiconductors, chemicals, and electric vehicles — have been announced at ever-increasing rates since 2021.8

If companies defer or cancel these projects, that could tell a story about the economy in 2024. But so far, only Ford has delayed construction of a $3.5 billion battery plant in Michigan.9

Kevin Toney, CFA
Kevin Toney, CFA

Chief Investment Officer

Global Value Equity

¹FRED, “30-Year Fixed Rate Mortgage Average in the United States,” Federal Reserve Bank of St. Louis, November 30, 2023.
²Federal Reserve Bank of Atlanta, “Business Inflation Expectations,” Special Questions Series, November 2023.
³Board of Governors of the Federal Reserve System, “Remarks on the Economy and Prioritization of Bank Supervision and Regulation,” November 9, 2023.
⁴American Bankers Association, “ABA Report: Bank Economists See Weakening Credit Conditions Through End of 2024,” September 26, 2023.
⁵Andrew Haughwout, Donghoon Lee, and Daniel Mangrum, et al., “Credit Card Delinquencies Continue to Rise — Who Is Missing Payments?” Liberty Street Economics, Federal Reserve Bank of New York, November 7, 2023.
⁶Board of Governors of the Federal Reserve System, “Senior Loan Officer Opinion Survey on Bank Lending Practices, October 2023.
⁷American Institute of Architects, “Architecture Billings Index: Architecture firm billings decline sharply,” September 2023.
⁸Eaton Corp., “Third Quarter 2023 Earnings Release,” October 31, 2023.
⁹David Shepardson, “Fed pauses work on $3.5 billion battery plant in Michigan,” Reuters, September 25, 2023.

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References to specific securities are for illustrative purposes only, and are not intended as recommendations to purchase or sell securities. Opinions and estimates offered constitute our judgment and, along with other portfolio data, are subject to change without notice.

International investing involves special risk considerations, including economic and political conditions, inflation rates and currency fluctuations.

Investment return and principal value of security investments will fluctuate. The value at the time of redemption may be more or less than the original cost. Past performance is no guarantee of future results.

Historically, small- and/or mid-cap stocks have been more volatile than the stock of larger, more-established companies. Smaller companies may have limited resources, product lines and markets, and their securities may trade less frequently and in more limited volumes than the securities of larger companies.

Diversification does not assure a profit nor does it protect against loss of principal.

Generally, as interest rates rise, bond prices fall. The opposite is true when interest rates decline.

Past performance is no guarantee of future results. Investment returns will fluctuate and it is possible to lose money.

The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments' portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.