Q2 2024 U.S. Equity Outlook
Growth Stocks
Corporate Earnings Are Crucial to 2024 Stock Market Returns
Stocks went on a months-long rally to unprecedented highs in early 2024. Contributors included hope for Federal Reserve (Fed) rate cuts, rising expectations for an economic soft landing, and investor optimism around artificial intelligence (AI) and obesity drugs. However, the fact that corporate earnings significantly improved late last year also played a pivotal role in the rally.
Earnings are key because stock returns are a function of earnings growth, dividend yield and the price investors are willing to pay for these earnings. Companies recently issued earnings guidance that pushed up full-year 2024 estimates. We view this as positive, reflecting a stable economy with firms able to navigate the current environment despite significantly higher interest rates.
Today’s Returns Depend on Tomorrow’s Expected Earnings
The market is forward-looking, trading more on expectations of future growth than what’s already in the books. For this reason, we expect the market to focus more on 2025 earnings estimates by mid-year, which we think look a bit high. Future earnings depend on the broader economy and Fed rate policy. The more restrictive the Fed stays, the more difficult the environment for future earnings growth.
From a style standpoint, growth companies' earnings outperformance relative to value companies means the valuation spread between the two has converged meaningfully. Of course, this relationship had become very stretched, so growth stocks went from being very expensive relative to value to merely expensive. However, if these aggressive 2025 earnings estimates turn out to be correct, then faster earnings growth and reasonable valuations should support growth outperformance in the future.
On the face of it, current conditions are generally favorable for growth stocks. Fed Chair Jerome Powell told Congress the Fed will cut rates this year. Risk-on sentiment, broader earnings growth and avoiding a recession all support stock gains and a broader rally beyond a handful of the very largest stocks.
However, one perhaps underappreciated concern for large-company earnings is that these firms generate significant revenues overseas. The reality is that Japan, Europe, and China are struggling economically.
Productivity Is Central to Profit Growth
In addition, we continue to see lasting challenges to productivity growth in the movement toward nationalism, deglobalization and demographic trends of social inequality and aging global populations. Why the sharp turn to talk about productivity? Because worker productivity is critical to corporate profit growth. We hope that advancements and uptake in AI and other technologies may help offset these productivity declines over time.
Moreover, uncertainty remains high on several fronts, which we think explains today’s extreme market concentration. In addition to the economy, interest rates and inflation, wars and elections introduce other sources of potential volatility. Progress on any or all of these fronts could lead to broader market participation.
To summarize, near-term conditions for growth stocks are favorable, contingent on companies achieving aggressive future earnings targets. But it’s also important to acknowledge the high uncertainty around present economic conditions.
Trends Support Productivity and Innovation
Longer term, we take heart in the fact that we see many enduring growth trends driving productivity and innovation. These include:
Corporate investments to support business security and continuity.
Government support for investments in renewable energy, infrastructure and manufacturing.
A more flexible and distributed remote work model to expand the labor pool.
Ongoing enterprise digital transformation.
A healthy financial sector to ensure capital availability.
Innovation and investments in technology and tools to drive productivity.
Ultimately, we remain confident that well-run, high-quality companies with a capability for sustained long-term growth can outperform over time.
Value Stocks
While Interest Rate Hikes Have Paused, Their Impact Persists
Even as central banks have let up on raising interest rates, we have anticipated that the effects of monetary tightening will continue to course through the economy for some time.
One of these effects is the ability of companies to manage debt.
Companies that accumulated debt during the accommodative period preceding and during the COVID-19 pandemic will be tested by the prospect of refinancing at higher rates.
Well-run enterprises with solid fundamentals may navigate the arrival of maturity walls when their high-yield debt must be refinanced by shoring up their balance sheets and streamlining their operations. Low-quality companies, however, will likely find this new environment troublesome to navigate.
Some $2 trillion in global debt will mature in 2024; nearly $2.8 trillion will mature in 2026. Over these three years, the share of speculative-grade maturities — corporate debt considered below investment grade — will increase from 12% to 20% of the total debt coming due. The media, entertainment, health care and telecommunications sectors lead the $1.49 trillion of speculative-grade debt that will mature over the next three years.1
Finding a source of credit has become more complex. The banking industry, rattled twice in less than a year due to well-publicized troubles of select regional banks, continues tightening its commercial and industrial loan standards.2
Companies can turn to private credit, but that avenue usually favors businesses with durable cash flows.
The coming maturity walls will arrive. High-quality companies, the type we look for when making investing decisions, are more likely to withstand these maturities. Low-quality companies, meanwhile, may find themselves making difficult choices.
A Banking Crisis or Banking Hiccup?
New York Community Bancorp (NYBC) has again made investors nervous about the regional banking system. Consider the year NYCB has had so far:
NYCB announced in January that it took a $252 million loss, cut its dividend and set aside reserves to cover anticipated losses on loans to commercial real estate.
A month later, it took a $2.4 billion goodwill impairment, discovered material internal weaknesses in its loan review process, and its CEO departed.
NYCB stock was in freefall until getting a $1 billion outside capital infusion. Regional bank stock indices have been mixed on the NYCB news.
So what are investors to make of this latest banking industry dilemma?
On one hand, it’s fair to say that NYCB’s problems are unique to the bank itself.
NYCB’s commercial real estate exposure had concentrations in downtown offices and rent-regulated apartments in New York City. Given the property types and the realities of New York City real estate, these are risky investments and aren’t common features of other regional banks’ real estate portfolios.
On the other hand, we worry about what NYCB’s problems may represent in the broader banking industry.
For one thing, NYCB took risks when it became more aggressive and embarked on recent acquisitions. It isn’t the first bank to be tempted by the allure of growth, nor will it be the last.
Banks broadly have exposure to commercial real estate, which is under pressure around the country, not just in New York City. With interest rates elevated and behavioral shifts by consumers and office workers after the pandemic, the potential peril for investors in commercial real estate is higher now than five years ago.
And banks are inherently risky, owing to their opacity. For example, what other banks aren’t minding the store regarding their real estate underwriting? As with NYCB, we often don’t know until we know.
We gravitate toward banks that we think have better credit. But NYCB’s issues, as idiosyncratic as they seem, are how credit cycles can start. So, we remind ourselves to stay cautious and keep a mindful eye on the industry.
Lower Charge on Electric Vehicles
Last fall, Ford Motor Co. withdrew its full-year guidance as it contended with a union strike and decided to delay $12 billion worth of investments in electric vehicles (EVs) as demand sagged.
Ford and several other automakers bet big on EVs in 2023. They counted on pent-up consumer demand from pandemic-related supply shocks that caused vehicle shortages in prior years.
Instead, they got consumers who largely remain hesitant about EVs due to pricing and the reliability and availability of charging stations.
After early adopters paid a premium for their EVs, demand fell flat. Automakers have delayed investments in EV production and lowered their projections for EV sales. Suppliers to automakers suffered, too. Shares of auto technology supplier Aptiv PLC, for example, took a beating in 2023 due partly to decelerating EV sales.
In February, Ford CEO Jim Farley told analysts that “the journey on EVs is inevitable.” Perhaps, but we think EVs have several problems to overcome first.
Consumers are concerned about the range an EV can travel before needing a charge. And then there’s the problem of finding an EV charger when the battery runs low. Speaking of batteries, what about the cost to maintain and replace one? J.D. Power puts that figure between $4,000 and $20,000, more than many common engine or component repairs in other vehicles.
We think EVs will continue to grow and advance. However, automakers must resolve consumer misgivings about EVs before growth ramps up.
¹Evan M. Gunter, Patrick Drury Byrne, and Sarah Limbach, “Credit Trends: Global Refinancing: Maturity Wall Looms Higher for Speculative-Grade Debt,” S&P Global Ratings, February 5, 2024.
²Board of Governors of the Federal Reserve System, “The January 2024 Senior Loan Officer Opinion Survey on Bank Lending Practices,” February 5, 2024.
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 risks, such as political instability and currency fluctuations. Investing in emerging markets may accentuate these risks.
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.