Interest rates will come down, but our panelists don’t see another magnificent year for stocks. Eight picks to beat the odds.
It is always a stockpicker’s market. You just have to pick the right stocks. If you picked the so-called Magnificent Seven last year—a group of highflying, mostly tech stocks that powered the S&P 500 to a 24% gain—you looked in the mirror and beheld a genius.
It is always a stockpicker’s market. You just have to pick the right stocks. If you picked the so-called Magnificent Seven last year—a group of highflying, mostly tech stocks that powered the S&P 500 to a 24% gain—you looked in the mirror and beheld a genius.
This year, it might be wise to avoid mirrors.
With a few exceptions, the members of the 2024 Barron’s Roundtable expect the stock market to disappoint, with the index delivering returns of minus-5% to plus-5% for the full year. No, they don’t see a ruinous recession, and yes, they expect the Federal Reserve to lower interest rates at some point during the year. Their main worry is that stocks are too richly valued, leaving little margin for error.
Those with a sunnier view cite massive capital investment across the economy, the promise of new
technologies like artificial intelligence, and incipient investor affection for the less magnificent 493. Bullish or bearish, these 11 money managers and market mavens duked it out Jan. 8 in New York, at a daylong gabfest hosted by
Barron’s. They also shared their best investment bets for the new year.
A few more notes: The 2024 Roundtable featured two newcomers—Rajiv Jain, chairman and chief investment officer of GQG Partners, a global asset manager with $120.6 billion in funds under management, and John W. Rogers Jr., founder, chairman, co-CEO, and chief investment officer of Ariel Investments, a global value-oriented asset management firm that oversees about $15 billion. Also, the group delved into politics a bit more than usual this year, propelled by the potential investment implications of the coming election and their growing concern about America’s fiscal burden.
In addition to big-picture prognostications, Week One of our three-part Roundtable series includes the investment picks of Meryl Witmer and Todd Ahlsten. Meryl, a general partner at Eagle Capital Partners, shops among the unnoticed and underpriced, while Todd, chief investment officer of Parnassus Investments, pounds the table for “great American companies,” also underpriced. Read on for an edited version of this year’s lively proceedings.
Barron’s: Todd, you were the most bullish of our bunch last year, so let’s kick things off with your predictions for 2024.
Todd Ahlsten: I remain relatively positive on the markets. I have a year-end price target for the S&P 500 of 5225. That implies a roughly 12% return, based on my expectation that the index will trade for just over 19 times 2025 estimated earnings of $270.
I am focused on three things: How does the S&P 500 look as an asset class? How does the economy look? And, how do monetary policy and liquidity shape up?
The S&P 500 is an awesome asset class. Think about the innovation in cloud computing, semiconductors, life sciences, industrial automation, transportation, electrification. This index is a collection of advantaged assets that continue to get more advantaged. TAMs [total addressable markets] are increasing, as are profit margins. Return on capital was more than 22% last year. We are looking for earnings to grow by at least 10% in 2024, and more than half that growth will probably come from the Magnificent Seven
Alphabet,
Amazon.com,
Apple , Meta Platforms, Microsoft, Nvidia
Tesla. There are massive waves of capital investment going on in the economy, in AI, cloud computing, and elsewhere.
Doesn’t the market reflect a lot of good news?
Ahlsten: Stocks started last year at 17 times future earnings. The S&P’s price/earnings multiple now is roughly 20 times, which isn’t cheap, but reasonable. We expect to see broader participation in the market this year. Industries such as housing, transportation, and shipping have had rolling recessions. As they recover, the market’s breadth will improve.
The economy will be a bit of an adult swim this year, with significant crosscurrents. We are in a period of higher interest rates and lower liquidity, but entering a period of lower rates and more liquidity. The economy might exit the year in a stronger position in a more supportive environment.
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Growth is decelerating, and we could have a soft recession in the second or third quarter, but the outlook isn’t grim. We have a 3% year-end target for the
10-year Treasury yield. Commodity prices are relatively low, and it is an election year, so we might see some fiscal stimulus, as well, toward the end of the year.
The politics of America are problematic, for sure, but too many people inflict their political views on their economic and investing outlook. We need to remember that we are investing in an awesome asset class with widening TAMs, increasing margins, and higher cash flows.
What do you worry about?
Ahlsten: Trade wars, China, politics, the possibility of a hard landing, the long and variable lags of monetary policy. Interest rates have gone up at the fastest rate in 40 years. On the other hand, the consumer is in relatively good shape, as are corporate balance sheets. A lot of companies extended duration on their debt.
Sonal, monetary policy will be center stage again this year. How do you expect things to unfold?
Sonal Desai: I’m out of agreement with the market much less than I had been.
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I’ll make four points on the macro backdrop. At this time last year, the federal-funds rate was at 4.25%-4.50%. Now, it is at 5.25%-5.50%. The Federal Reserve has indicated it is likely to cut rates by 75 basis points this year, although as recently as a few weeks ago, the market was pricing in 150 basis points of rate cuts. [A basis point is a hundredth of a percentage point.]
We expect the Fed to lower rates by 75 basis points, but March is too soon for reductions to begin. The economy is robust. Inflation isn’t falling rapidly enough to justify a cut in March. Given the massive bond and equity market rallies at year end, financial conditions take us back to when the fed-funds rate was 1.75%. The market has eased for the Fed.
Second, I am struck by the Fed’s newfound lack of prudence. In December, the Fed took a well-deserved victory lap on inflation, which has declined substantially, without much damage to the economy. But I was surprised that the Fed softened its language to the degree it did, encouraging the markets to believe there will be a rapid return to abundant liquidity and an extremely low fed-funds rate.
Third, fiscal policy is enormously loose. The fiscal deficit needs to be financed. Given that it is an election year, I’m not surprised that we just got a top-line agreement on the federal budget. Neither the Republicans nor the Democrats are going to curtail the fiscal spend this year.
Finally, in the medium term, we are moving to normalize policy. I expect that will take us back to the old normal—the pre-global-financial-crisis normal. The markets and the Fed are looking at the wrong neutral rate of interest. They expect something like 2.25%-2.50%. I believe the long-term neutral rate is closer to 4%.
We expect more volatility in the coming quarters, with the 10-year yield possibly going back toward 4.50% and ending the year around current levels. Todd, what would your S&P 500 forecast be if the 10-year Treasury yield were 3.75% or 4%?
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Ahlsten: It would depend on why yields were higher. The companies in the S&P 500 did a great job of managing inflation. Earnings could be higher because of higher nominal GDP [gross domestic product]. Also, what type of multiple would the market put on higher earnings? I would probably maintain my price target, depending on why rates go up.
Bill, what is in your crystal ball?
William Priest: I have a somewhat different take. I see a roller-coaster year.
Globalization is over; the law of comparative advantage is running backward. We are unwinding the efficiency and security of supply chains, which means higher costs. Different trading blocs could develop as the year unfolds. Countries will want to trade with “friends.” We’ll wind up with a world of more tariffs. Nevertheless, the dollar will maintain its haven status. The deficit, and spending on Social Security and healthcare, military and education, and the interest on the debt are enormous.
All these trends create a modest negative backdrop for the stock market. They are also bad news for emerging markets, which benefited from low-cost labor. Now, AI and other technologies are supplanting labor. If you can substitute technology for labor costs and hold revenue constant, your margins go up. If you can substitute technology for physical assets, your asset returns go up. There isn’t a company in the world that isn’t focusing on these principles.
Also, the growth rate in China is likely to fall sharply. China will be lucky to see 3% GDP growth next year. It will never see the population it has today unless it gets birthrates up. The growth rate is a function of growth in the workforce and growth in productivity. It is hard to see growth in China that isn’t in the low-single digits.
Moving on, central banks will tolerate higher inflation because they have an excuse: It isn’t their fault! The problem is related more to supply than demand. Cash-flow growth of 12%, which seems the standard expectation for 2024, is too optimistic; 6% to 8% seems more reasonable.
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My biggest worry is that democracy appears to be ebbing. I don’t know what that means for free markets and valuations. Harvard professors Steven Levitsky and Daniel Ziblatt wrote a good book on the subject published in 2018, How Democracies Die. Autocracy is on the rise.
In more mundane matters, what is your market forecast?
Priest: It is a plus-5%, minus-5% kind of market this year.
Abby, what is your view?
Abby Joseph Cohen: Todd and I had the same forecast for last year. We were more optimistic than everyone else in this room.
Apologies. We should have begun with a duet.
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Cohen: I see some differences in our views this year. Last year saw a heavy concentration of performance in the S&P 500. The relative price/earnings multiple of
the so-called Magnificent Seven was 1.7 times the S&P 500 multiple, while the rest of the index traded at 0.9 times the market’s P/E.
This will be a year of alpha—that is, stock selection—not beta, or just hugging the index. Last year, even S&P 500 companies were hurt by exposure to Europe and emerging markets. I don’t see that changing dramatically. I share people’s concerns about China.
Also, while U.S. consumers are in good shape, they aren’t in the same great shape as last year. Consumers entered 2023 with extreme levels of excess savings and demand. They wanted to spend not just on goods but also on experiences: Taylor Swift tickets, heavy-duty travel. Hotel stocks were among the market’s best performers. Some of that ammunition has been used up, and there is a little more friction in the labor market. The unemployment rate is low, but there aren’t as many open jobs available relative to people looking for work.
Many companies in the S&P 500 immunized themselves against rising interest rates by issuing long-term debt at low rates. I strongly agree with Bill, however, that we will see increased costs from onshoring. We’ll also see more corporate spending on technology, and duplicative spending on energy as we move toward green-sourcing.
There will be significant issues this year in the U.S. Congress. It is good to see a top-line budget agreement among congressional leaders and the White House, but we don’t know whether members of the House of Representatives will vote for it. There could be a government shutdown as soon as Jan. 19, or on Feb. 2. I am also concerned about the politicization of foreign policy, something relatively new for the U.S. I worry about funding for Ukraine being held back because of domestic political considerations. It is one thing to have an objection to such funding, but it is disturbing that it is tied up with election-year politics. It is highly disturbing that we haven’t yet provided funding to resupply our defense companies, or for Israel or Egypt.
Where does this leave the market?
Cohen: My valuation work leads me to an S&P 500 target on the order of 5000. I don’t anticipate earnings or cash-flow problems, but am concerned about price/earnings ratios and other valuation metrics. Also, the risk premium might rise in the U.S. A government shutdown could have a negative impact on the dollar, and on the credit rating of Treasury securities. I don’t expect a notable drop in interest rates.
Now for some book recommendations. In The Crisis of Democratic Capitalism, Martin Wolf discusses the balance between democracy and capitalism that allows economies to grow. I also have a fiction recommendation, because we’re all getting so serious here. James McBride’s The Heaven & Earth Grocery Store is a tale of people from different backgrounds coming together as a community.
Does anyone else have a recommendation for the Barron’s Book Roundtable?
Ahlsten: Breath, by James Nestor, looks at the science of breathing. Breathing through the nose reduces stress, anxiety, and fear.
Let’s all try it now.
Mario Gabelli: There are a lot of issues to consider. The U.S. and China represent over 40% of the world’s $110 trillion of gross domestic product. In the U.S., data on the consumer sector, 70% of the economy, remain positive, but we are mindful of the inflation impact on low-income households. The industrial sector will benefit from reshoring and fiscal stimulation, and there is pent-up demand for single-family homes.
Overall revenue for U.S.-based operations will remain solid, with gross margins improving. Selling, general, and administrative costs are under control, but interest expense and rising corporate taxes, along with selected currency concerns, are trimming some of the profit improvement.
My bigger concern deals with the $34 trillion of U.S. debt. The U.S. needs to grow revenue and hold costs. The Federal Reserve continues to try to contain inflation and reduce aggregate demand while fiscal policy is increasing demand. This results in higher-for-longer interest rates, a higher deficit, and a drag on the economy.
The market has discounted some of this, but the main concern I have is an “event.” Iran is trying to develop a nuclear bomb. North Korea and Russia have nuclear weapons. Four years ago, we didn’t think about Russia invading Ukraine. We didn’t think about a bank crisis last year, or the Mideast crisis. Is the market prepared for an event such as the use of a nuclear weapon, or the prevention of its use, that could cause a 20% to 30% selloff?
Is it ever prepared for such things?
Gabelli: With regard to interest rates, [Fed Chair Jerome] Powell can’t make another mistake. What will he do if oil prices, now around $72 a barrel, shoot up? The U.S. has taken the Strategic Petroleum Reserve down to 50% and has to rebuild. This reduces supply and increases demand and leaves you and me vulnerable to an energy shock, as in the 1970s.
But what does it matter? Short-termism is prevalent as algorithms, momentum investing, and exchange-traded funds influence trading. The
Dow industrials will be the equivalent of 1,000,000 in 40 years and was under 1,000 about 40 years ago. So, invest long term.
I am in the plus-5%, minus-5% camp that Bill mentioned for the Dow and S&P 500. Keep your seat belt fastened. You want to own businesses that will flourish, bought at a fair price.
Rajiv, are you ready to dive in?
Rajiv Jain: I think so, because I disagree with at least half of what has been said. First of all, the survival of democracy has no correlation with stock market performance. South Korea didn’t have fair elections until 1993, but the stock market did well for 30-plus years before that. The same was true for Taiwan, Chile, and China. Things could go the other way, too, as happened in Russia two years ago.
The seminal event of the past few years was the Russia-Ukraine war. It divided the world into countries that have energy security, such as the U.S., Canada, and Brazil, or are willing to buy oil from Russia. Europe is a basket case. Liquefied natural gas went from $3 per million British thermal units to $13 per MMBtu—which no emerging market can afford in the long run without bad things happening. The Eurozone Manufacturing PMI [purchasing managers index] peaked in late 2021, and has tanked since the war. France and Germany PMIs are back at almost the lows of the 2008-09 financial crisis, and in some cases worse.
Power prices in Germany have gone up more than 50%. You can’t operate a chemical or almost any manufacturing plant with those kinds of prices, if sustained. Germany is reopening lignite coal mines because it shut down nuclear power plants and offshore wind isn’t dependable. The ESG [environmental, social, and governance] bubble is bursting in stock markets because reality is sinking in. You can’t say no to fossil fuels because half the world would starve without fossil. China is getting cheap Russian gas for $2.50-$3.50 per MMBtu. They’re doing fine from an energy perspective.
What were the best-performing currencies against the dollar in the past three years? Not the euro. The yen is a disaster. The winners are the Mexican peso and the Brazilian real. I disagree with Bill. Emerging markets are doing fine, with the exception of China.
The Chinese economy is kind of OK. The Chinese stock market isn’t. Chinese state-owned enterprises are doing much better than the private sector. That’s the negative part of heavy-handed intervention in the public sector.
What do you see in the rest of Asia?
Jain: Countries like Indonesia, Malaysia, and India are in pretty good shape. In Latin America, we have never been more bullish on Brazil. GDP and equity markets are doing well despite little stimulus during Covid and high interest rates.
From a market perspective, there is a tale of two cities. Corporate earnings in the U.S. and Europe have been far stronger than anyone expected, which is why the markets have done well. But the corporate reforms in many countries have been quite significant, and that is a positive from
a broad market perspective, minus Europe. We feel that until the energy sanctions against Russia are reduced or lifted, the European economy would have a tough time gaining traction.
Cohen: Fascinating comments. For the first time ever, we have seen that FDI [foreign direct investment] into China has stopped. Are you seeing the FDI redirected to some other emerging economies?
Jain: Yes and no. Mexico is a big beneficiary of nearshoring, or offshoring moving away from China. India and Indonesia have seen some foreign investment. We have seen a cycle play out over the long run: Good markets lead to bad policies, which lead to bad markets, and then to better policies, which lead to good markets. We are entering the good-markets phase after good policies over the past few years.
Brazil has privatized some of the most difficult companies to privatize, like its largest power company. Saudi Arabia has almost 60 companies lined up for privatization in the next couple of years. Government ministers say, “We want to make sure you guys make money.” From Europe, all we get are more penalties or regulations—nationalization of utilities, for example—while emerging markets are privatizing them. Other countries are privatizing them. My point is, policies are very different now in some of these emerging countries. That is bullish.
That said, multinationals aren’t doing as well as they used to in a lot of emerging countries because of the growth of domestic competition.
Unilever is barely getting 2%-3% volume growth in some of its bigger emerging markets. The largest banks in these countries are far better than European banks. Several banks in Brazil have $30 billion or higher market capitalizations, comparable to Europe, but with much higher return on equity.
You haven’t said much about the U.S. Are you bullish or bearish?
Jain: I’m very bullish. I agree with Todd. I am not bullish on the economy, but the broad market is dominated by some of the highest-quality companies globally. They figured out ways to make money. Also, the U.S. still has $3 gas. If power prices go up 60%-70%, Europe’s industrial base will be hollowed out, but that isn’t the case in the U.S.
Henry, give us your two cents.
Henry Ellenbogen: I agree that the risk-free rate of interest will be higher. In the past few years, people tended to focus on the tensions in world affairs. But the big message for all asset owners is that capital isn’t going to be free any more. I remember Bill mocking modern monetary theory at this table a few years ago. I don’t hear anyone talking about MMT today because central banks, including our Fed, have been clear that it was a failed experiment.
If capital isn’t going to be free, we have transitioned from an era driven by speed and momentum investing to an era of skill and judgment. That means it is a stockpicker’s market. Transitions are bumpy, but companies no longer get a free pass to drive profits or growth. They now have to do both, which is healthy.
A lot of the excess was in smaller companies—SPACs [special purpose acquisition companies], more than 400 IPOs [initial public offerings]— and private markets, whether venture capital or private equity. Investors in private markets are just starting to take markdowns. Public-market investors took markdowns in 2022.
I agree with Mario: You have to take a long-term view and be positive on the prospects for the U.S. The agility and ability of the American business sector is like nothing else in the world.
Last year, you were enthusiastic about AI. What lies ahead?
Ellenbogen: We are winning the next major cycle in technological innovation. AI drove most of the S&P’s gains.
Duolingo, one of my 2023 picks, is a microcosm of what can be done with AI. The company is using AI to write curricula not only in language but also in math and music. It is using AI to personalize education.
GitHub from Microsoft Copilot is increasing the productivity of software engineers. We are so far ahead of China on this. Europe hasn’t even gotten to the starting line. So, yes, there are reasons to be concerned politically in the U.S., but when you think about our business culture and innovative capability, the story is positive.
Americans tend to get more pessimistic toward Election Day. That impacts consumer confidence. By the fourth quarter, however, people will see that earnings are accelerating, as the Fed has signaled it will be easing. I see a modestly up year, probably tilted toward post–Election Day.
Investing in AI will be expensive. How will companies manage the costs, and when will we see revenue from this technology?
Ellenbogen: AI is as big if not bigger than all the technology waves I have seen in my career: internet, mobile, cloud. Certain companies, like
Uber Technologies, wouldn’t exist without mobile technology, but it also benefited traditional businesses like
Domino’s Pizza. Cloud computing benefited the insurgents. With AI, incumbents can do well. Companies don’t need to retool their infrastructure, or change customer incentives. But they need to do the heavy lifting to have their data in a clean structure, or they need to have clean code. Companies with modern architectures and modern code bases are getting a lot of benefits. Yes, there will also be losers. Some S&P 500 companies will have to prune other things out of their cost structure to invest in AI.
Gabelli: The New York Times has sued Microsoft and OpenAI for copyright infringement. Is this the Achilles’ heel of AI? [Holds up newspaper.]
Ellenbogen: No, because licensing is something we have already dealt with. YouTube resolved copyright lawsuits. The rights holders got paid. The same will happen here.
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, is talking about a $400 billion accelerator GPU [graphics processing unit] market by 2027. That is a massive ramp from about $45 billion today, where Nvidia’s data-center revenue sits. It implies more than $1 trillion of data-center and cloud AI spending by 2027. But to your point, Mario, we have a $650 billion digital ad market. That is going to monetize AI. Life-sciences companies and players like
Intuit, Microsoft,
Adobe, Amazon, and Google are all going to put capital behind AI.
Desai: Expectations seem to have run ahead of what AI can deliver.
Ellenbogen: The leading tech companies are already getting substantial value from AI. Dispersion of the technology to traditional companies will take more time. Also, great consumer applications haven’t been written yet. Sure, there is hype in the stock market, but it will dissipate. Then, the companies that drive value will do well.
Scott, join the conversation.
Scott Black: I’ll start with the economy. I expect to see a deceleration in real GDP growth this year, but not a recession. Most forecasts put real GDP growth somewhere between 0.7% and 1.4%. The key for the stock market this year will be whether the Fed breaks the back of inflation like [Former Fed Chair Paul] Volcker did in the early 1980s.
The consumer price index, ex-food and energy, is now around 4%. Some forecasts put 2024 inflation at 2.4%. If inflation really gets down to that level, rates can come down, but I expect the Fed to stay the course for the next three to six months. I don’t look for any diminution in the fed-funds rate. The market will be choppy, and its performance will depend on whether we defeat inflation.
The other thing you should look at is M1 and M2 [money-supply measures]. They are contracting. M1 is down 9.6% year over year, and M2 is down 3%. The Fed’s balance sheet had $7.74 trillion of total assets as of Jan. 3. That’s down by $842 billion year over year, and down from $9 trillion at the high.
Monetary policy has been highly contractionary, but our chronic fiscal deficit is a disaster. It was $1.54 trillion last year, according to the Congressional Budget Office, but will rise to an estimated $1.57 trillion this year and to $1.76 trillion next year. The deficit is running at about 6% of GDP, which is unsustainable. The national debt is now $34 trillion, or about 1.23 times GDP. We are on a perilous course.
Gabelli: The government put back $300 billion of theoretical student-loan forgiveness against the deficit, so the actual default for the fiscal year just ended was much higher than the reported number.
Black: The interest on the debt will be $745 billion this year, creating a crowding-out effect.
Gabelli: Scott, pay more taxes.
Meryl Witmer: Who should the U.S. government tax to raise more revenue?
Black: They need to increase taxes on corporations.
Witmer: The amount raised would be too small, and it is bad policy.
Black: They will also have to rein in spending. There isn’t a lot of discretionary spending in the budget. We were talking about these issues 15 years ago. At some point, we will have to face the music.
Now, let’s talk about valuation. Bottom-up estimates for the S&P 500 are $242.44 for 2024, implying a 13% gain year over year. That is unrealistic. My estimate, $230, represents a 7.6% increase. I assume a 1.4% gain in real GDP and 2.5% CPI. Then I add about 40 basis points of operating-margin improvement. My estimate implies that the market is trading for 20.4 times earnings. It is slightly expensive, given the level of interest rates.
The
Nasdaq 100 and the
Russell 2000 benefited tremendously when bond yields fell late last year. The Nasdaq 100 is trading for 27.9 times expected earnings, and the Russell is trading for 26.8 times. Others have said it will be a stockpicker’s market. I don’t see much direction to the market in the next six months, until we know that the Fed can cut rates.
Every year, it seems, we say it’s a stockpicker’s market. Meryl?
Witmer: I heard Steve Schwarzman [the CEO of
Blackstone] speak recently. Although the numbers that Powell looks at are as Scott described, Schwarzman said that based on his adjustments, the inflation rate today is really about 2.5%. The Fed will likely be a couple of quarters behind, but rates will come down.
I’m a stockpicker, and I don’t see a lot of good values. The 401(k) [retirement plan] money will flow into the market, probably lifting stocks in January. But I wouldn’t be surprised to see a 5%-10% drop thereafter. We might see some opportunities then, and I see some positive things about the U.S.
John, what is your outlook for ’24?
John W. Rogers Jr.: Bill discussed possible challenges to our democracy. We are all on pins and needles about the 2024 election. Partisanship exists like never before. Yet, many of us go to the
Berkshire Hathaway annual meeting every year, and Warren [Buffett, CEO of Berkshire] reminds us every year that our capitalist democracy is the best system ever invented. We always find a way to regain our winning edge. Mario talked about the importance of thinking long term. Our logo is a turtle. We believe in patience.
The market’s performance has been bifurcated. On one side are large-cap growth stocks, on the other small-cap value. According to
JPMorgan Chase, the 20-year average P/E multiple of the large-cap growth index is 18.9. Recently, it was 26.5. The 20-year average P/E for small-cap value is 16.7. Today it is 16.3. We have seen the valuation gap between large growth and small value before. In 2000, the S&P 500 was flying. But when the dot-com bubble burst, small-caps outperformed large-caps by 42%.
I wouldn’t be surprised to see the S&P 500 down 10% to 15%. It is overvalued after posting a great return in 2023. We see opportunity in the small-cap value space. You might expect me to say that, given much of my life’s work, but there are a lot of neglected stocks. The research on small-cap value is the worst I have ever seen.
Witmer: There isn’t any.
What will spark a turnaround?
Rogers: We talk to the management teams of our holdings every quarter. During last year’s second and third quarters, there were a lot of earnings disappointments. Today, you can feel the optimism building. Company management teams are buying stock personally, at a higher level than I have seen in a long time, and corporations are buying back stock. Earnings growth will power the recovery.
Ellenbogen: To put that in context, the S&P 500 missed estimates by 2% to 3% last year. The Russell 2000 missed by more than 20%. The S&P 500 outperformed the Russell 2000 purely because of earnings growth.
Gabelli: Don’t forget that bank stocks make up about 20% of the Russell 2000. When we had a bank crisis in March, centered on the value of hold-to-maturity assets, those stocks fell, hurting the index.
Cohen: One of the catalysts for a small-cap turnaround will be mergers and acquisitions. The preconditions are valuations and earnings growth. Many larger companies are flush with cash and have low interest rates on their debt. They are looking to expand. Private-equity investors are also potential buyers. Money keeps flowing into private equity. Whether that is sensible or not is beside the point.
Ahlsten: Amazon.com, Alphabet, and Microsoft also could be buyers. They can’t just buy other large companies due to regulatory issues.
Gabelli: Today, three healthcare deals were announced. We have also seen a tsunami of deals in the oil patch. You are going to see a lot more corporate lovemaking.
Rogers: I agree with Abby that private-equity dollars are massive, and as rates go lower, people will be able to do more deals. Also, the Fed lowered interest rates in 2001. It didn’t help growth stocks outperform; the opposite happened.
Black: I invest in many mid- and small-caps. As a risk class, mid- and small-caps have systematically underperformed the S&P 500 since 2007. Interestingly, the Russell 2000, which had an upturn in November and December, outperformed the equal-weight S&P 500 last year by three percentage points.
Also, about 40% of small-cap companies have no earnings, so it isn’t fair to say the Russell 2000 is cheap. It is expensive. You can’t say it trades for 17 times earnings, ex-negative earnings. If you include everything in the index, the multiple is 26.8 times. Meryl is right: It comes down to individual stock selection. As a homogeneous risk class, I’m not convinced small-cap outperforms large-cap over time.
Rogers: There is so much pessimism because of what Scott said. The late John Templeton always said you want to buy when there is maximum pessimism. Most of us value managers are getting up in age. You don’t see a lot of young value managers. But once everyone gives up on a sector, that’s where the opportunity is.
Priest: Andrew McAfee and Erik Brynjolfsson published a great book in 2017, Machine, Platform, Crowd, about platform economics. Once you start to substitute technology for labor and physical assets, the scale effects are enormous. The endgame is winner take all. I think it’s game over for a lot of small-caps. They will find it difficult to compete other than through partnering or selling out to larger companies with scale.
We won’t resolve this debate but we can get David’s take on the world.
David Giroux: Over the past six years, the macroeconomic consensus has so often been wrong. At the beginning of 2018, the S&P 500 traded for 18-19 times forward earnings. The expectation was rates would go to 4%, and the economy would see rip-roaring growth. Earnings grew by 20%-plus that year, and yet the market was down. Investors worried late in the year about a recession, and rates fell.
In 2022, 100% of economists, when surveyed, said we would have a recession and high rates forever. Yet, today everyone is expecting lower rates, lower inflation, and a soft landing.
Bringing that back to markets, if I could choose between a rosy macroeconomic outlook and lower valuations, I would always choose lower valuations. We are probably not going to have a recession in 2024. Interest rates will likely come down. But stocks are expensive; there is no margin of safety. The macroeconomic consensus has to be right to support stocks here. I agree with Bill that it will be a minus-5%/plus-5% kind of year. On a five-year basis, we are looking for a 6.5% average annual return, below trend. Yet, there are still values.
Such as?
Giroux: We see good value in managed care, life-sciences tools, utility stocks, and waste. We still see good value in companies like Microsoft, Intuit, and Salesforce, which has a low valuation. I was underweight energy for a decade, but we are seeing good value in energy now as some supply-and-demand dynamics have changed.
AI is in its early days. Large companies are still doing beta testing and trying to figure out the scope of this technology. GitHub Copilot for engineers can increase productivity by 50%. Return on investment on this technology is off the charts, well north of 100%.
The long-term beneficiaries are software companies. A lot of large-cap software companies are growing revenue at 10% or more. With AI, in the second half of the decade, they could increase that growth rate by one or three percentage points. AI will also deliver a big bottom-line benefit. If a programmer will be 50%-100% more productive in four years, you won’t need to hire as many programmers as in the past. Software companies will likely generate more margin expansion.
Microsoft is the premier way to play AI on a long-term basis. The stock is a little more expensive than it used to be, but not much more expensive. Three years prepandemic, it traded for 1.53 times the market multiple. Today, it trades for 1.59 times.
We should also consider the second-derivative effects of AI. Over time, it will lead to an imbalance in supply and demand for white-collar workers. It will push growth lower, and the unemployment rate will probably be structurally higher than in the past decade. It will also make 2% inflation more achievable long-term.
One more thing: As a balanced manager, we still see good value in high-quality leveraged loans and high-quality high-yield bonds.
What will we be talking about when we gather a year from now?
Ahlsten: An economic recovery, lower interest rates, lower inflation, a higher stock market, and a better outlook for 2025.
Priest: Continued deterioration in the geopolitical situation.
Rogers: An extraordinarily complicated election whose outcome could be thrown into the Supreme Court.
Rajiv: More of the same. Most trends are protracted. Geopolitics won’t shift dramatically, and the U.S. economy will be fine.
Cohen: We’ll be talking about the U.S. election and leadership in several other nations. Things look a little dicey for leaders in France, Germany, and the United Kingdom. We may be dealing with a different cast of characters next year. Also, I agree with John that our election consequences could be messy. And we’re all going to come with new book recommendations. Hopefully, some will offer comic relief.
Black: The outcome of the election could be an issue.
Giroux: We’ll be talking about AI, and the potential for $3 trillion of tax cuts to expire in 2025. We’ll be talking about the Magnificent Six instead of the Magnificent Seven, as Tesla will be out of that group. It could be a big underperformer this year. It is an auto company with a high valuation, and is losing market share.
Is there a logical replacement in the Mag Seven?
Giroux: There are probably other names you could put in that group today, whether an Adobe or a ServiceNow. Lastly, I expect the economic consensus to be very different a year from now.
Ellenbogen: From an investment perspective, we are firmly in the world of positive real rates. Companies will have to be agile, and you will want to invest in those that balance growth and profitability.
Despite the challenges, we will be aware that the U.S. is unique in the world. We have population growth above the replacement rate, and whether you call it luck or something else, our business climate is unique. We are the world leader in AI. We could also be talking about GLP-1s [diabetes and weight-loss drugs], which won’t be supply-constrained in the future, and could bring down healthcare costs. As the supply increases, you could see price cuts. We are the most obese country in the world. Shifting the curve on obesity could improve productivity and lower healthcare costs.
Desai: We will be talking about many of the same things we discussed today, because nothing will be solved. And we will definitely be talking about the U.S. fiscal position. Also, my macro forecast was pretty darned close last year. Just noting.
Gabelli: We will spend a lot more time trying to figure out how to solve our fiscal problems, which will become more visible after the election.
Witmer: The U.S. will be fine. We tend to muddle through. Taxes have to go up. Nonprofits should probably be taxed on incoming funds. The large estate-tax exemption is due to sunset at the end of 2025. That will raise some money.
Desai: As an economist, I have to tell you that the only solution on taxation is a VAT [value-added tax]. That is how the rest of the world finances progressive policies. Unfortunately, you can only finance a progressive wish list with a regressive tax, the VAT, and not with our complicated tax system.
Witmer: So, let’s get rid of some of the progressive wish list.
And let’s move on to your stock picks. Meryl, you have the floor.
Witmer: My first pick is
Graham Holdings. The stock is trading for $680 a share. It has 3.6 million Class B shares, which trade, and 0.96 million Class A shares. The market cap is $3.1 billion. The A shares control the vote and are owned by the Graham family, which also owns a lot of B shares. I have zero concerns about unfair dealings, given their ownership of two share classes. Graham CEO Tim O’Shaughnessy, who is married to a Graham family member, is a rational businessman. His true north is to generate increasing amounts of free cash flow per share, which is music to my ears.
Graham owns a lot of businesses. What are they?
Witmer: We value Graham on a sum-of-the-parts basis. Kaplan International is the biggest of its education businesses. It partners with universities predominantly in English-speaking countries, and helps international students matriculate by helping them fulfill academic and English fluency requirements. It also owns housing, which it provides to the students. KI has long-term contracts with most of the schools with which it works.
With the school year that started in September 2023, the business is getting back to baseline post-Covid and should see continued improvement. At some point, it could see incremental growth from the U.K. government increasing its tuition cap, which has been flat since 2017. KI could also benefit as the U.S. student-visa administration clears an 18-month backlog. The education segment has higher-education and supplemental-education divisions, as well. Upside could come from the possibility that U.S. colleges will again require standardized testing for undergrad admission.
The education segment had adjusted operating cash flow of $169 million in the 12 months ended in September. We calculate free cash flow of $135 million and value the business at 8.5 to 11 times free cash. Using the midpoint, that’s $1.23 billion.
What else does Graham own?
Graham’s broadcasting segment owns TV stations in various U.S. cities. Operating cash flow has been steady when averaging election and nonelection years. We value this business on the average of the past two years’ operating cash flow, minus $13 million for capital-spending needs. At a multiple of 5.5 times free cash, the business is worth more than $1 billion.
Graham also has a manufacturing business that we estimate has been hurt by $20 million a year due to the slowdown in commercial office space. The other businesses are solid, with Hoover Treated Wood a gem. We put a 7.5 multiple on 12-month trailing free cash flow of $56 million, to value all the manufacturing businesses at $420 million.
Graham also has a fantastic healthcare segment. It offers in-home hospice care and infusions via wholly owned and joint ventures. Competitor Option Care Health trades at a rich multiple. We are conservative, however, and put an 8.5 multiple on free cash flow. Adding $100 million for joint-venture interests, we get a $450 million valuation.
The automotive business owns car dealerships. We value that at seven times pretax free cash, or about $260 million. Graham also has an “other” segment, including restaurants and Framebridge, a custom framing business. We value the segment at just over $200 million.
Graham has a pension fund that is overfunded by $1.6 billion, or almost $350 a share, pretax. It is finding innovative ways to use the earnings on the excess to retain nurses in the healthcare segment. Starting this year, it will offer a pension contribution in lieu of a 401(k)-account match, which should save about $10 million a year while sheltering earnings. We value this at $525 million, but it could be worth much more.
Other assets include loans to universities, cash of $160 million, and $575 million of equity holdings. There is also $762 million in debt, and we value unallocated corporate expense at about negative $400 million. Add it all up and we get $835 a share. With free cash flow of over $100 a share in the next two years and growth in the business, we expect Graham to trade above $1,000.
Ellenbogen: We have some overlapping healthcare investments. Graham’s healthcare division is probably worth twice your estimate, and the unallocated segment has a lot of profitability. As people realize the quality of the healthcare business and it approaches $100 million of operating earnings over the next couple of years, the stock will rerate. Conglomerates tend to trade at a discount to the value of their holdings until one division really excites people.
Witmer: My next and last pick is
Wintrust Financial, trading around $91. It has 61.2 million shares outstanding and a market cap of about $5.5 billion. Wintrust is a financial holding company with 15 community-bank subsidiaries in Illinois and Wisconsin, and a leasing company and wealth management operation. It also lends to insurance agencies and finances life-insurance policies, a specialized and profitable business.
Wintrust has total loans of about $41 billion, including $10 billion to commercial real estate, but only about $3 billion of that is for office and mixed-use properties. Charge-offs are only about 0.1% a year, and nonperforming assets were 0.26% at the end of September. Deposits total $44 billion, with $10 billion at zero interest cost.
Wintrust has been earning at about a $10 a share annual run rate, up from $8 in 2022. Book value was $75.19 at the end of September. By the end of this year, with retained earnings, it should be about $86. A multiple of nine or 10 times earnings is too cheap for this kind of quality. The stock should compound nicely over time.
Thanks, Meryl. Todd, you’re up.
Ahlsten: I started covering semiconductor stocks soon after I joined Parnassus at age 22, but we didn’t own Intel then. It wasn’t a value stock. Today, it is more so. The market cap is $203 billion—more than 50% below the peak in 2000. There is a chance that in three to five years, Intel could be one of the Magnificent Seven. The CEO, Pat Gelsinger, has said this could be one of the great turnarounds in U.S. corporate history. I won’t go that far yet, but we bought the stock in May after not owning it for several years.
Intel lost market share to AMD in central processing units [CPUs] for PCs and servers. It fell behind
Taiwan Semiconductor Manufacturing in process technology, and far behind Nvidia in GPUs, used for AI applications. Annual revenue has fallen from about $70 billion to the mid-$50 billion area since 2019. Gross margins have fallen by 17 percentage points while research-and-development expenses have spiked by 7.5 percentage points.
How will a turnaround happen?
Ahlsten: Intel will reduce structural costs. More importantly, Gelsinger is doubling and tripling down on process technology. Intel is positioned to potentially reclaim the lead with gate-all-around technology, the next frontier in transistor architecture for the industry. This increases the power, efficiency, and productivity of Intel’s CPU and GPU chips. The company will be an early adopter of high numerical aperture EUV [extreme ultraviolet], a type of equipment used in photolithography. It is using new bonding and packaging, and packaging its chips with wires, logic, and memory. Intel can start to stabilize and regain market share in several areas. It is an American icon. I like to buy great American companies.
Intel will put $120 billion of capital to work over five years to become a foundry to the world. Pat is separating the company into a design business and a foundry. This is a difficult endeavor.
What makes you think it will work?
Ahlsten: In September 2022, former
Cadence Design Systems CEO Lip-Bu Tan joined the Intel board. He is a specialist in electronic design automation. In three years, the GPU and foundry businesses could each have $2 billion to $3 billion of incremental sales, making them somewhat competitive with Nvidia and TSMC. In the long term, the foundry segment could do tens of billions in sales. There is a chance that Intel will be building parts for Nvidia, Apple, and Google by 2030. I emphasize “chance.”
Intel’s stock gained 90% last year, to a recent $47. In three years, Intel could have more than $4 a share of earnings power, and more than 25% operating margins. Apply a multiple of 18 times earnings and you get a stock price of $72. The company’s long-term target is to get to a 60% gross margin and 40% operating margin.
Will being a foundry and design firm create conflicts?
Ahlsten: Intel is building two companies in one. It is breaking out the financials, and there will be increased accountability in both businesses. We’ll know in 2025 whether the story works. The stock’s downside is in the mid-$30s.
Black: Nvidia and
ARM aren’t going to stand still. How will Intel compete?
Ahlsten: The growth of accelerated computing will require a lot of CPUs. Plus, Intel is innovating elsewhere. People want an alternative to Nvidia, which we also own.
Oracle offers a rare chance to invest in AI, software, artificial intelligence, and cloud computing at a reasonable multiple. The market cap is $280 billion. The stock is trading for $104, or 18 times earnings. We see upside to $155 in 2½ years, based on a 4% yield on free cash flow. Unlevered free cash flow could total $20 billion in fiscal 2027.
There is a lot of durability in Oracle’s cloud-transition story. The company could sustain a 50% growth rate in infrastructure as a service for the next couple of years. Second, Oracle is transitioning from licensing-based software to a SaaS [software as a service] model. Meanwhile, the database business has stable cash flow.
Oracle’s transition isn’t cheap. In our view, capital sending for the cloud infrastructure segment will be $6 billion to $7 billion. Oracle is trading at a 10% discount to the market. Last fall, it traded at a 15% premium.
I’ll probably double down on my third stock,
Deere, for the rest of my career. It is such a great company that you want to buy it, close your eyes, and go drink beers in Thailand for 10 years.
Speak for yourself, please.
Ahlsten: About 16% of global climate emissions come from agriculture. Deere’s precision ag technology can help reduce water, fertilizer, and pesticide use, and crop inputs. The company has a wide moat. We are in an ag downturn; corn prices fell 30% last year, putting pressure on farm income.
Gabelli: But farmers’ cash receipts will still be $520 billion to $525 billion this year, way above the average level of the past 10 years.
Ahlsten: The fleet age is still OK. Dealer inventories aren’t that elevated. Deere is getting better with each cycle; margins are peaking at higher levels. Deere could earn $24 a share in 2025 in our bear case. The stock is trading for $400, so you’re not paying a high multiple. It could trade up to $540 in two years, based on a multiple of 18 times midcycle earnings of $30 a share in 2026. By then, it could have 1.5 million connected machines and 500 million engaged acres, 250 million of them highly engaged.
Black: You left out Deere Financial, a substantial earner for Deere.
Ahlsten: It is a fantastic asset and has low loss rates, backed by strong farmer balance sheets and land.
Thermo Fisher Scientific is a fantastic company in life sciences. It is known for reagents and lab tools. The valuation has been suppressed for three reasons. Annual revenue for Covid testing peaked around $9 billion during the pandemic and could fall to $300 million next year. Also, we saw a great biotech funding environment in 2021, which has ended. And, China has reduced its purchase of life-sciences tools.
Thermo Fisher should return to revenue growth this year, and mid- to high-single digit growth in 2025. The company earned about $22 a share in 2023 and trades for 24 times earnings. You’re buying it at a cycle trough. The stock could trade at about $750 in three years, or for 25 times 2027 estimated earnings of approximately $30 a share.
What is the driver?
Ahlsten: Thermo has a trophy collection of assets and recurring revenue. It is building the backbone for all sorts of molecules used in drug research and development. It has a great record in M&A. The CEO, Marc Casper, puts capital in the business. We don’t know when business from China will return, but it was only 8% of revenue, and we have a biotech funding trough. But long term, research spending is up and to the right, and Thermo, along with
Danaher, which I also own, should do well.
Last night I stayed at a Marriott hotel.
Marriott International has 72% underlying Ebitda [earnings before interest, taxes, depreciation, and amortization] margins, and a 25% return on capital. The stock trades for $222, or 23 times earnings, and the market cap is $65 billion. Marriott is the largest premium hotel company, with 16% share, and has 31 brands. It has been a high-quality compounder for years.
There is a structural imbalance between supply and demand for hotels, especially in the premium market. Pre-Covid, there was 2%-3% annual supply growth. Now, with inflation and higher interest rates, growth is down to 0%-2%. Demand growth was 3%-4% in the decade through 2019. Now it is 4%-6%, given the travel rebound and other factors.
What does that mean for Marriott?
Ahlsten: RevPar, or revenue per available room, grew by 2%-3% in the past decade. Growth could be 3%-6% in the next decade. There are 192 million people in Marriott’s loyalty program, Marriott Bonvoy, which the company is leveraging to generate non-hotel revenue. Management expects 18%-19% of fee income to come from non-hotel sources through 2025.
Marriott has a good pipeline of new properties that could generate $500 million of Ebitda in three years. The stock has upside to $280 in two years, when it could trade at 22 times 2026 estimated earnings of $12.75 per share.
Ahlsten: I like them both.
Intercontinental Exchange trades for $125, or 21.5 times earnings, and has a $72 billion market cap. The company owns financial exchanges; Black Knight, a provider of mortgage and real estate–related technology; the Ellie Mae mortgage-processing business; and a fixed-income information business. About half the business is exchanges, and roughly 35% of the exchanges serve the energy market. They are increasingly valuable, given the volatility in energy prices. Between Black Knight and Ellie Mae, ICE can now digitize and automate the whole mortgage process. ICE has had nice customer wins.
Even though 76% of ICE’s mortgage technology revenue is recurring, the company faced headwinds last year around the Black Knight acquisition and uncertainty in the housing market. Now, it is all systems go. ICE could realize $200 million of deal synergies in the next few years and then start buying back shares again. We see $8.60 a share in earnings power in 2027. Based on a P/E multiple of 25, we get a stock-price target of $215.
Thank you, Todd.
