SBH Investment Summit
Fourth Quarter 2023:
Economic and Market

2023 Market Dynamics and What it May Mean for 2024

While the stock market has been surprisingly strong in 2023 (driven by large cap tech), concerns about risks to corporate profitability and valuations remain. Despite this, our experts are optimistic about their 2024 “shopping list” of strong companies to invest in once valuations improve.

Ralph Segall, CFA, CIC, Chief Investment Officer, and Suresh Rajagopal, CFA, Director of All Cap Strategies, Director of ESG Research discuss the impact on companies of rising interest rates, the higher cost of employment, and the decoupling of the global supply chain.

Key Takeaways

  • Rising short-term interest rates have not slowed economic activity as expected, but higher rates are impacting valuations (with declines in commercial real estate being a good example).
  • The recent UAW contract exposes cost risks to the Big Three automakers, placing them at a substantial competitive disadvantage to the non-unionized rivals and making us question their growth potential since productivity gains are lacking.
  • While reshoring manufacturing and rebuilding domestic supply chains are strategically important, it requires major upfront capital investments and will take years of efficiency gains before providing economic benefits.

[Ralph Segall] Today we plan to talk about the domestic stock market thus far in 2023 and what we are thinking about for 2024. The motif of the market so far in 2023 has been a surprisingly strong market that has been led by large cap technology. That surprised us because of the issues we have seen in the marketplace and what we think that should be doing to valuations. Suresh, can you discuss those issues?

[Suresh Rajagopal] A couple of things that we talk about frequently from a macroeconomic standpoint are rising interest rates, which for us has an impact on valuations, the cost of employment, the income statement cost that companies are going to face which is going to impact their earnings, and the decoupling of the global supply chain that we are seeing from what happened during COVID with China and the rest of the world. Let’s start with the rising interest rate environment and what impact that has on stocks and their valuations.

[Segall] One thing that has been happening in the last 18 months has been short-term rates coming up substantially. They have not had as much of a significant impact on economic activity as you would have thought, but there are leads and lags in terms of the operation of higher interest rates. One of the things that they do is affect valuations. And if anybody thinks that interest rates do not do that, all you have to do is look at valuations of commercial real estate and what has been going on there and you will appreciate the problems that that can create.

[Rajagopal] One of the things that we talk about frequently when it comes to rates and valuation is the seven stocks that have dominated the market in 2023. If you look at the valuations and growth rates and where they would need to be in order to justify those higher valuations, it is very hard for us to put a sandbox or framework around that to say those are stocks we want to own in this kind of environment, especially as the volatility picks up. One of the other things that we talk about is just the overall cost of operations for these companies, and we focus on the cost of employment. A news headline that we frequently discuss has been the United Auto Workers (UAW) contract that was recently signed.

Ralph, could you discuss the historical perspective as it was a substantial raise to the UAW, but the impact is more to the tier one, tier two, and tier three suppliers that have to overcome those costs?

[Segall] The UAW contract is striking in a couple of ways. At the very end, there were a number of younger workers that were opposed to it because the older workers were getting substantial raises and job opportunities that were not going to the younger workers. The labor pact that was signed is going to put the Big Three automakers at a substantial competitive disadvantage to the non-unionized auto companies, mostly the foreign companies that are operating, that have manufacturing operations in the United States. This makes us wonder how much growth that will lead to since productivity gains for the auto companies right now are not there, particularly as they struggle to build the electrified portion of their portfolio.

[Rajagopal] The final thing that I would like to discuss is the decoupling of the supply chain. As we started seeing that unwind happen during COVID, why is that important? There is a capital expenditure to onshore what is critical to national importance and there is a J curve. It is great to have the manufacturing come back to the U.S., but you still have to spend the time to build it and build the efficiency in the manufacturing; those are all costs early on, before any benefit is seen. To us, the benefits of that are years down the road, not months or quarters, and that is going to take time to work through the system. That is something that we think about. Ralph, why don’t you expand on that further?

[Segall] The three things that we have talked about raise concerns that we have about the risks to corporate profitability, both from squeezes on margins and pressures from interest rates, higher labor costs, and the impact that that will have on the valuations that investors put on stocks because of the higher interest rates. From our point of view, while we have been avoiding the companies that we think are going to be at risk from pressures like this, we have been building our shopping lists. We are not quite sure when we want to put those lists to work, but we are looking at companies, making sure that we understand what their intrinsic earnings power is, what valuations we would like to pay, and we are waiting for our opportunities. We think that 2024 is going to be a great opportunity for us and we look forward to being able to take advantage of that on behalf of our clients.

 

 

Additional Resources:

Domestic Equity Insights

All Cap Strategy

 

The opinions expressed in this video are solely the opinions of Segall Bryant & Hamill or an unaffiliated third party. You should not treat any opinion in this video as specific inducement to make a particular investment or follow a particular strategy, but only as an expression of opinions. The opinions expressed in this video are based upon information considered reliable, but completeness or accuracy is not warranted, and it should not be relied upon as such. Market conditions are subject to change at any time, and no forecast can be guaranteed. Any and all information perceived from this video does not constitute financial, legal, tax, or other professional advice and is not intended as a substitute for consultation with a qualified professional. The opinions and statements are subject to change without notice and Segall Bryant & Hamill is not obligated to update or correct any information in this video. For illustrative purposes only.

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