The second of two Perspectives outlining some of the key themes we think will drive the major industry sectors in 2024.

Each January, we ask our team of research analysts for their outlooks on the major industry sectors for the year ahead.

With the U.S. election potentially coinciding with the first rate cuts since 2020, this looks set to be another eventful year. With that in mind, we have dedicated two CIO Weekly Perspectives to some of those key themes from our analysts, starting last week with the Healthcare, Energy, and Power and Utilities sectors, and concluding today with Technology, Financials, Consumer and Industrials.

Technology: Transformative Growth, Fierce Competition

The Technology sector has been one of the biggest investment stories of the past few years, and 2023 was no exception, with Semiconductors and Internet stocks leading the way.

Our Semiconductors analyst Jamie Zakalik calls artificial intelligence (AI) “one of the most significant secular growth developments since the invention of the internet.” Its new prominence gave the chips sector almost the perfect set-up in 2023, coinciding as it did with many companies’ fundamentals hitting their cyclical troughs and starting their recoveries.

Can that incipient earnings recovery justify today’s valuations? We believe so. Semiconductor cycle recoveries have tended to last two or three years, on average, and we believe AI will continue to be a top theme. Jamie tells us to look out for how AI processing evolves from aggregated large-scale AI training to smaller-scale edge and on-device AI inference, for example.

Beyond Semiconductors, AI touches almost the entire sector. In Cloud Computing, firms that can invest aggressively in AI should be able to generate new revenue streams over the next few years. The potential for AI to transform the Digital Advertising experience could counterbalance the sector’s cyclicality somewhat. Generative AI has made search a competitive battleground almost overnight: Intellectual property in search models is still key, but data, brand, distribution and relationships with advertisers remain critical.

But it’s not all about AI.

While our Internet and Hardware analyst Daniel Flax says that Cloud Computing trends remain healthy longer-term, he expects the near-term focus to remain on workload optimization. Regulation also remains a key theme in the sector, especially for platform companies, and we closely monitor ongoing investigations and policy shifts. As the sector faces an increased focus on privacy, some of the larger platforms are still well positioned to grow, driven by strong execution on their product roadmaps and their first-party data.

Even in Semiconductors, there are important dynamics in addition to AI. Industry automation, electrification and connectivity remain significant growth opportunities. Meanwhile, different chip markets are going through an asynchronous cycle: We think those first into the correction—such as PCs, smartphones and memory—can continue to recover, to different degrees, through 2024, while markets like communications equipment, industrial and automotive, which came into the slowdown later, could be softer through the first half of this year.

Financials: Banks Bounce Back, Alternative Asset Managers Soar

Election politics, the macroeconomic background and the path of interest rates loomed large in last week’s industry outlook piece. Unsurprisingly, we also see them as key drivers of Financials through 2024.

Bank stocks started 2023 with a crisis, and endured months with an inverted yield curve. They came back to life in the fourth quarter as markets began to price for lower rates, earnings estimates began to stabilize and signs of easing appeared on the regulatory front. Valuations are attractive, but our analysts remain wary of lenders with above-average commercial real estate exposure and are seeking out stocks with potential re-rating catalysts, such as restructuring.

In Insurance, our analyst Chai Gohil is most bullish on Personal Property & Casualty (P&C) insurers, which had a good 2023. Price increases have outpaced losses despite rising inflation, so Chai thinks these businesses can generally continue to expand margins through 2024, justifying current valuations. In contrast, we think the pricing cycle in Commercial P&C has matured and the resulting reorientation to growth could threaten margins.

Chai thinks the Life Insurance sector enjoys clearer tailwinds—unlike banks, they benefit from higher rates as they result in higher investment income and stronger annuity flows. Underwriting trends also seem positive. We continue to monitor the potential impact of the U.S. Department of Labor’s updates to the Fiduciary Rule, as well as the credit quality of the private debt that has gone into many insurers’ investment portfolios over recent years.

As in the rest of the Tech sector, competition in Payments & Fintech remains fierce but rational: Nearly all players are intensely focused on margins and profitability. We think a key differentiator will be the ability to grow software and value-add services as non-transactional sources of revenue, particularly in the face of a potential consumer-spending slowdown. Overall, however, payment volumes remain steady, and some stock valuations are getting support from private equity interest and a comeback in M&A.

Alternative Asset Managers is among our Financials analysts’ highest-conviction subsectors. Many entered 2023 facing concerns about the valuations of illiquid assets, and the potential for waves of fund redemptions that they would struggle to meet. However, valuations held up and fundraising was better than anticipated, sparking a meaningful recovery in share prices. We think a relatively stable macroeconomic background through 2024 should support that recovery by helping asset realizations. We also see several candidates for inclusion in the S&P 500 Index, following Blackstone’s entry in 2023, which could broaden and stabilize the subsector’s investor base.

Consumer: Normalization After Four Years of Volatility

The macro backdrop is key for the Consumer sector. Optimism is based on strong real wage growth, easing inflation, and the robustness of the consumer’s liquidity and apparent willingness to eat into savings. But our Retail and Ecommerce analyst John San Marco thinks this needs to be tempered by the uncertain employment outlook, mixed signals from the state of the consumer’s balance sheet, and potential lagged impact from interest rate volatility.

As such, we are cautious about areas of spending that are still being over-consumed or where cumulative inflation and price elasticity are creating risks. Consumer value and a normalization of the sector’s dynamics after years of pandemic and post-pandemic volatility are key themes for us in 2024.

Much of the risk in Consumer Services is centered in the Discretionary sector. Here, revenue growth is highly dependent on pricing power, and that pricing power appears to be running out as customers cut back on post-pandemic treats—we already see less willingness to trade up when eating out, for example. Retailers should fare better, John argues, as 2024 is likely to be a year of recovery from the extreme pandemic-related volatility and operational challenges of 2022 and 2023: We think wallet share will stabilize this year, and investor expectations are more comfortably achievable in Retail than in Consumer Services.

We are more positive on Staples as a group, as abating currency and commodity headwinds lead to more normalized sales and earnings growth, and investors recognize the sector’s relatively attractive valuations.

Industrials: Quality, With an Early-Cycle Opportunity

In Industrials, inherent cyclicality underscores the importance of the macro background—but the micro matters, too. On the one hand, a general stabilization in manufacturing, normalization of inventories, a general loosening of supply chains and easing in commodity input costs are all supportive. On the other, sourcing semiconductors remains a challenge, and the sector is exposed to key policy debates, especially those impacting the electrification trend and defense.

All that said, our Industrials analyst Evelyn Chow thinks company specifics and known subsector growth drivers are likely to hold the key to outperformance in 2024.

In Aerospace, Defense & Transport, we take a positive view overall and particularly favor aircraft production and its aftermarket, where we see support from growing underlying travel demand and attractive valuations. We also like freight, primarily in the form of rail operators in the nearer term, but with an additional secular growth opportunity in the less-than-truckload (LTL) market. In Autos & Machinery, we are more neutral overall, focused on quality and single-stock opportunities.

Across Diversified Industrials we are moderately positive, favoring potential short-cycle beneficiaries and electricals exposed to the datacenter buildout, as well as quality earnings compounders that could benefit from a more accommodating rate backdrop. Throughout the sector, Evelyn highlights the importance of M&A and spin-off stories, and a preference for margin “self-help” where companies can better control their own destinies.

A Normalization and a Cyclical Inflection

The sectors we have considered this week are, for the most part, more cyclical than the ones we looked at last week. Thinking about their prospects for 2024 provides an important reminder that we have been going through one of the first genuine slowdowns in the business cycle for years—that is, an economic slowdown that does not owe its immediate origins to a bursting investment bubble, a financial crisis or an exogenous event like the pandemic, but to supply and demand in the real economy and the response to monetary policy.

While 2024 is likely to be a year of normalization following the era of zero rates and the pandemic, conditions may nonetheless be new and unfamiliar to many business leaders and market participants. We think that suggests an intriguing set of opportunities.

In Case You Missed It

  • Bank of Japan Policy Meeting: The BoJ held interest rates at current levels
  • Japan Manufacturing Purchasing Managers’ Index: +0.1 to 48.0 in January
  • Eurozone Manufacturing Purchasing Managers’ Index: +2.2 to 46.6 in January
  • U.S. Durable Goods Orders: +0.0% month-over-month (excluding transportation, durable goods orders increased 0.6%) in December
  • U.S. 4Q GDP: +3.3% quarter-over-quarter (seasonally adjusted annualized rate)
  • European Central Bank Policy Meeting: The ECB made no changes to its policy stance
  • U.S. Personal Income and Outlays: Personal spending increased 0.7%, income increased 0.3%, and the savings rate decreased to 3.7% in December

What to Watch For

  • Tuesday, January 30:
    • Eurozone 4Q GDP
    • S&P Case-Shiller Home Price Index
    • U.S. Consumer Confidence
    • China Manufacturing Purchasing Managers’ Index
  • Wednesday, January 31:
    • January FOMC Meeting
  • Thursday, February 1:
    • Eurozone Consumer Price Index
    • U.S. ISM Manufacturing Index
  • Friday, February 2:
    • U.S. Employment Report

    Investment Strategy Team