09 Feb Stock tips for your portfolio in 2024
Kyle Wales of Flagship Asset Management talks to Simon Brown on Moneyweb about the offshore sector, China’s fall from grace and his stock picks for the challenging year ahead.
As Wall Street hits consecutive record highs in the waning weeks of January, the reality is in 2024, the long-delayed recession could well land and likely market declines, potentially led by the “Magnificent 7” AI-centric tech stocks, equate to a reasonably hawkish outlook. So where can investors seek refuge during what looks to be another highly unpredictable year?
Forecasts have admittedly proved notoriously unreliable, with 2023 a good example. Whereas the prevailing view was that recession would set in, US growth materially outperformed expectations. The Bloomberg Median US 2023 GDP forecast at the end of 2022 was a mere 0.3%. However, the latest US GDP data released this week shows that the economy grew by 3.3% in the fourth quarter versus expectations of 2%.
GDP was not the only macroeconomic data point that outperformed US expectations in 2023. In addition to GDP, the US labour market was stronger than expected, and inflation declined despite the strong economy. In other words, the ultimate Goldilocks scenario unfolded.
Perhaps even more startling than the performance of the economy was the stock market’s performance. The S&P 500 closed the year up 24% for the year and the Nasdaq a blistering 54%. After this run, market valuations are definitely sitting at very elevated levels. The blended forward price-earnings (P/E) ratio for the S&P 500 is 20X versus a long-run average of 16.7X. For those of us who believe in mean reversion, as I do, a market correction seems long overdue.
Lopsided Returns
Looking more granularly, another noteworthy observation in 2023 is how lopsided market returns were. The “Magnificent 7” (which consists of Apple, Microsoft, Google, Nvidia, Meta, Tesla, and Amazon) accounted for 76%[1] of the S&P’s total return in 2023 on the back of AI-led exuberance.
While there is no question that AI is a game-changer, market expectations around similar game-changing technologies have been hopelessly optimistic in the past. The internet Bubble of the late 90s/early 2000s comes to mind. While the internet was unquestionably a game changer, it took many years for most “dot.com” companies to grow into their valuations, and many never did, as they failed along the way.
Firstly, we believe selective fast-moving consumer goods (FMCG) stocks offer value. These are stocks which should perform well in the event of a recession. I choose to emphasize the word “selective” because many FMCG stocks trade on high multiples relative to their growth prospects and are, therefore, not attractive. We are looking for those stocks that trade on a wide valuation gap relative to their own histories and can grow in line with their peers. In this case, a stock like Heineken springs to mind.
Secondly, European defence is a sector that appears interesting and doesn’t often attract attention. European countries have long underspent their NATO budgets, and their attention has been drawn to their lack of military preparedness as a result of the war in Ukraine, which is entering its third year. This is especially true for Europe’s largest economy, Germany. Amongst European defence companies that appear worthy of consideration are Hensoldt and Thales.
These companies are trading on mid to high teen multiples but are expected to grow their revenues and earnings in the low teens. This translates into a very reasonable PEG ratio of just over 1X. In addition, this growth is reasonably secure because their clients are the government, and their order books are full.
China
Finally, it would be remiss not to discuss China, where stocks performed abysmally, in contrast to the excellent 2023 year experienced by its peers. The share price of a stock like Alibaba (a Chinese bellwether) has essentially moved sideways since its IPO (adjusting for the number of shares in issue), even though its revenues are 42 times larger.
The question then becomes: is 2024 the year to re-look at China shares? While we believe it is good to have some Chinese exposure, as valuations are just too compelling, we think investors should exercise some restraint before diving in. We believe Chinese valuations are low for a reason. The regulatory environment in China is unpredictable, and legal recourse against irrational regulations is non-existent. This is also playing out against a background of geopolitical unrest between China and the US.
While economists’ predictions are for a smooth ride in 2024, many factors give us pause for thought. We believe it pays to be cautiously positioned, despite what the bulls may say, and concentrate on the less beloved areas of the equity market that didn’t participate in the bull market in 2023.
However, whatever happens in 2024, there are sufficient unknowns and potential downside risks to make it likely that we will be taken by surprise.
About the author
Kyle Wales CA(SA) CFA
Fund Manager
Kyle is a fund manager and member of Flagship’s global investments team. Kyle has been investing internationally for over 15 years. Prior to Flagship, he worked at Coronation Fund Managers for 9 years in the Global and Global Emerging Markets teams, and also co-managed a global equities boutique at Old Mutual Investment Group. Kyle is a qualified chartered accountant and CFA charter holder.
