Weekly Market Update

If certain firms can “shoot the lights out” with unexpected profit growth, history shows their share price performance can match. This was certainly the case for the “Magnificent 7 ” during their multi-year ascent and their stunning comeback from a poor 2022.

But now, strong profit growth for the world’s most highly valued companies will not come as such a strong surprise.

Instead, a broadening of profit gains is likely to boost performance of other shares that “suffered their own earnings recession” in 2023. The healthcare sector in particular looks poised to recover from EPS declines last year.

Last year, the S&P 500 equal weight index fell behind the performance of the market cap weighted S&P 500 by the largest margin since 1998. This was because of the powerful gains among mega-cap tech firms. Indeed, a historically few number of firms were able to beat the S&P 500 last year.

In short, there were unusually few ways for active stock pickers to outperform in 2023. This is changing now as profits improve across more sectors even as large cap tech-related profits slow from a pace above 40% in 2023.

What does this mean for investors?

To be clear, we see potential opportunities for both tech and healthcare as the two “super sectors” that outgrow broad economy profits over the longer term. Much like the industrialization of the economy in the 18th/19th century, these are the sectors that the economy is “becoming.”

While flush with competition, cyber-security software is a critical element of “Economic Security” we discussed in last week’s bulletin. Semi-conductor equipment is a critical element of building secure technology supply chains. For long-term investors, we see a correction in related share prices as a mere “ripple in the tide.”

As we said, only the future counts for determining the value of equities. Guidance on future quarters matters most, and some firms that have experienced a huge lift to estimates in the year past will struggle to keep exceeding expectations.

After last year’s equity market gains, the picture of the economy we described is not likely to result in boom-style equity returns, but rather gains consistent with a “mid-cycle expansion.”

After a 5% pullback through mid-April, the S&P 500 has still returned 23% and the S&P 500 equal weight index 22%.

We saw US and global equity markets as mildly depressed a year ago as recession and inflation fears still dominated investor psychology.

Today, that depression rut is over. With this in mind, it is important that investors understand the long-term drivers of equity returns. Even in the past three decades of tech and growth stock dominance, dividend growth, when reinvested, has accounted for roughly half of the S&P 500 total return.

Firms that invest, innovate to create new products and dominate their industry outperform. But from a total return perspective, less innovative firms that are consistent growers of dividends catch up in time.