Broadening beyond tech-plus
Earnings expectations for the so-called tech-plus stocks that have been driving market returns since last year were exceptionally high ― and yet they surpassed even that lofty bar. Healthy revenue growth plus a cost base that was “right sized” in 2023 contributed to the strong results. Year-over-year comps also were not hard to beat after a dismal 2022.
We still like tech stocks and expect momentum from generative AI to continue powering earnings growth. Yet the biggest numbers are probably in, with comps getting tougher and earnings likely to decelerate from Q4’s very robust levels.
Meanwhile, we see reason to believe that earnings growth for the remainder of the S&P 500 could pick up. The technology sector broadly has been experiencing a different business cycle than the rest of the market. Bloated investing and hiring during the COVID-induced digitization of everything in 2020 and 2021 was followed by a reining in and normalization in 2022 and 2023.
Other sectors were having the opposite experience, suffering during COVID and still re-adjusting upward today. Healthcare procedures and travel plans that were delayed during the pandemic are back on and consumers are still playing catch-up on missed experiences. Q4 results for hotels, restaurants and leisure showed 88% yoy earnings growth and profit margins that are just now returning to pre-COVID levels. One major hotel chain noted their expectation for slower but still growing leisure revenues into 2024. We’re watching the consumer closely, given pockets of stress that we noted last quarter, and are acutely attuned to the impact that higher interest rates are having on wallets and purchasing decisions.
The example in EVs
Q4 earnings offered one notable example of where consumers are growing more guarded ― in the market for electric vehicles (EVs). The EV leader in the Mag 7 was the only name in the group to post negative yoy earnings growth in the quarter. Another major U.S. EV manufacturer noted in its earnings call “the impact of historically high interest rates” on demand while also announcing job cuts.
To be sure, the effect of higher rates on total purchase price is not the only factor in the EV slowdown. The market is experiencing growing pains as early adopters are at saturation and manufacturers look to penetrate the next layer of potential buyers. Technical issues around battery range and infrastructure for charging are also being addressed and some traditional car makers are refocusing efforts on hybrid vehicles over fully battery-powered models.
Yet the pullback in demand among EVs and other big-ticket items speaks to a more discerning consumer who is beginning to feel the bite of higher rates and prioritize purchases. A major home improvement chain, for example, noted that the consumer is still “healthy” and “engaged” ― but in smaller projects at this juncture.
As fundamental stock pickers, we are looking to identify those companies best positioned to weather a potential consumption slowdown as buyers grow more discriminating in their spending.
Bottom line
We expect a slowdown in the blockbuster tech-plus earnings alongside a pick-up in the rate of earnings growth in those areas of the market where COVID hangover effects are still being worked off. Dispersion in earnings is evident between and within sectors as companies adjust to a new era of higher rates and volatility. This, we believe, creates a fertile hunting ground for active stock pickers to source greater alpha opportunities in an environment where we believe beta, or market return, could underwhelm expectations.
