It’s time to turn toward the “unloved and undervalued” stocks, as David Sekera, Morningstar’s Chief U.S. market strategist, calls them. Indeed, “the concentration on large tech is myopically focused on the bull market of 2023,” asserts David Polak, equity investment director at Capital Group, who points to some surprising numbers concerning the “unloved”.
How Often Do You Hear Eli Lilly Mentioned?
Among the big tech stocks, Polak observes, only two really stand out: Nvidia (NVDA), with a return superior to 250% since January 2022, and Broadcom (AVGO), with 121%. Compared to them, other “magnificent seven” stocks show much more mundane results. For example, Meta (META) gained only 35.4% over the same period and Microsoft (MSFT), 25%, while Apple (AAPL) pedalled back - 3%, and Tesla (TSLA) fell 41%.
In the tech frenzy, names like Eli Lilly (LLY), ExxonMobil (XOM) and General Electric (GE) have seldom popped up. Yet since January 2022, Eli Lilly shot up by 218%, GE, by 175%, and ExxonMobil, by 55%. “Our point is that there is much more beyond the tech names,” Polak comments. “Yes, Nvidia has been a great stock, but so have been Eli Lilly and Exxon.”
Conditions Could Propel That Ride Along
As all financial disclosures state, past results don’t guarantee future ones, but conditions remain favourable for the “unloved”. The 3.6% retrenchment that happened in the month following the March record “is healthy”, Sekera believes. Even at present price levels, the market remains stretched, “but not overvalued”, he adds.
“I would expect returns in the range of 8% to 9% for long-term investors, Sekera continues. The market is not cheap as last October and it has already priced in a pretty positive outlook, but we’re not looking at a recession. What we see are mostly positives: a slowing economy, no recession ahead, inflation still moderating, and interest rate cuts. But having said that, the market is pretty close to fair value.”
It’s a diagnosis with which Polak agrees, adding: “Companies with clear earnings growth trajectories, pricing power and the ability to maintain market share should be able to weather potential storms.” In the fourth quarter of 2023, 76% of the S&P 500 companies beat earnings expectations, Capital Group reports, while 63% reported higher revenues than what analysts expected. LSEG Institutional Brokers’ Estimate system expects earnings growth rates to rise from 5.2% in Q1 2024 to 14.1% by Q4.
Equities Look More Exciting Outside the U.S.
The positive outlook holds outside the U.S., especially in emerging markets and for global corporations. In emerging markets, while earnings plunged by -10.8% in 2023, LSEG expects they could shoot up to 18.5% in 2024 and 15% in 2025, surpassing U.S. numbers. In the ACWI Index, most industries are attractively priced. Many are at or just above their 10-average forward P/E ratio (price/earnings ratio), notes Capital Group, at a time when central banks around the world are set to ease monetary policy, and longer-term interest rates are likely to decline.
AI’s Looking ‘Overloved’
Relinquish tech and AI hypnosis, propose Sekera and Polak. Maybe technology’s premium valuations are justified given their strong earnings, especially their new growth runway in artificial intelligence, but Sekera cautions investors to keep a skeptical ear. “Many companies will talk up AI, but not all will have a clear path, he says. I’ll be looking for specific plans: when a company plans to build AI capacity, when it will deploy it, and when it expects revenue from it.”
Perhaps better to steer clear of the hype and look at other “unloved” areas that present substantial potential. Polak points to energy transition, health care and industrials, while Sekera favours small-cap stocks in general, which present an 18% discount as a whole, and real estate, “the most hated category on the street”. Avoid urban office REITs, he acknowledges, but other areas that have been sold off too much remain attractive, notably those related to health care and cell towers. Though his long-term outlook on gold prices is bearish, he sees a lot of value in gold miner stocks like Barrick (ABX) and Newmont (NGT), which stand at discounts.
Canadian Stocks Have a Sturdy Profile
The outlook for Canada is surprisingly positive, submits Mike Archibald, vice-president and portfolio manager at AGF Investments. Here, growth potential certainly does not lie in tech stocks. “When you’re looking for growth,” he says, “it typically tends to lie in mid-cap stocks because the large caps, like RBC for example, are slower growers.”
The global context favours Canada’s traditional areas of resources, materials and energy, even financials. “We’re in a reflationary environment where commodities should do well,” Archibald asserts. “If we get in an environment where growth is pretty good, but inflation doesn’t fall quite as people expect, that should be good for Canada,” he says, “With resources like copper, gold and energy, you get an inflation hedge, while immigration is a lever for the financial sector because newcomers open accounts. If an environment of above-trend inflation persists, Canada offers you one of the best risk-adjusted opportunities in equity markets, mostly because of its resources.”
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