US Equity Roundtable

Three of our US equity portfolio managers discuss market conditions in 2023 and provide perspectives on positioning for the challenges ahead.

US equities have rallied in 2023, but investors are facing tricky conditions. Market gains have been dominated by mega-cap tech stocks, which benefited from investor perceptions that artificial intelligence (AI) could potentially drive superior long-term earnings growth. GDP growth has recently exceeded expectations and inflation has fallen, yet interest rates remain high. We asked three of AB’s equity portfolio managers to comment on the market environment and how they are positioning portfolios to find sources of long-term return potential.

Q: Market returns have been driven by a small group of mega-cap stocks this year. What are your thoughts on market concentration?

John Fogarty, Co-Chief Investment Officer, US Growth Equities: Market concentration has challenged investors like us who believe in the spirit and letter of diversification. We’ve seen periods of narrow market returns before, and they don’t tend to sustain for very long. This episode of market concentration has been incredibly extreme—I like to think of it in terms of market capitalization. We’re talking about $4.5 trillion across the top seven names, which is more than 10% of the entire equity market. These are mind blowing numbers, and at some point, I would expect these gains to reverse—or at least consolidate—as the market broadens.

James (Jim) T. Tierney, Jr., Chief Investment Officer, Concentrated US Growth: We’ve seen this kind of concentration in the past, but we’ve never seen it concentrated so tightly in one industry—technology. Recently though, the market has started to broaden out—the 10 largest stocks contributed 104% of the S&P 500’s return from January through May, but through July, they contributed 69%. This is benefiting active management. If you look back to three previous years when most of the return came from just 10 names, there’s some good news—the year after this happened, the pendulum swung back, and the market broadened out.

Q: Excitement over AI has been a big catalyst for the technology and internet titans. How should equity investors approach the AI trend?

Ben Ruegsegger, Portfolio Manager—Sustainable US Thematic Equities: We’ve been invested in AI for about 10 years and have held a position in one of the major chipmakers, for quite some time. But part of what we do for our clients is to look beyond that. We look at the entire ecosystem to find companies that are enablers of this technology. For example, AI is very energy intensive and many companies are looking for energy-efficient ways to deploy the technology. Companies like those in the power semiconductor segment will benefit over time from the proliferation of AI but are not necessarily in the spotlight for investors today.

Jim: At some point, investors will become far more skeptical of the AI ramp up. So, we must really dig in to determine which companies have real AI business models and which ones just have an AI halo. Beyond the small number of companies that enjoyed a big boost this year, we need to search for the real beneficiaries of AI. Do you believe that seven or 10 companies will monopolize the benefits of AI, or is AI a productivity tool that helps everybody? When implemented strategically, AI could generate big productivity improvements, which translates into cost savings and enhanced earnings. Over time, it could lead to a reduction in demand for labor—which is a big constraint in the US economy today. This, in turn, could lead to lower inflation and lower interest rates. So, there are many knock-on effects to AI that the market hasn’t even started to discount, and over time, I think that will benefit the broader market—not just the top 10.

John: I’m not denying that something huge is happening with AI. But we don’t want to assume we know all the winners. We want to verify it with actual results. Ultimately—for any company we look at as a beneficiary of AI—the share price, performance and valuation must conform with profit generation. We don’t want to pay for hope. We use our research to invest in growth companies with quality business models, and in some cases, AI provides optionality that is not yet embedded in the stock price valuation.

Q: Beyond AI, what other themes, trends or company-specific stories do you see in the market that can provide investors with strong long-term growth potential?

Ben: We invest in long-term thematic trends that should persist through changing macro conditions. And we’re always evaluating theme progress to make sure we are targeting the right themes and the companies most levered to these durable opportunities. Energy transition is likely to be a durable theme that should benefit from increasing government support for clean energy and efficiency efforts in the private sector. Last year was the first time that the amount of money invested in the transition away from fossil fuels exceeded the amount of money funneled to fossil fuels. Healthcare is another industry in which long-term trends are creating opportunities, from task automation to personalized medicine to government efforts to reduce costs. Electric vehicles (EVs) are poised for long-term growth, but we prefer to reduce some of the volatility around the theme, so instead of trying to pick the winning carmakers, we prefer to invest in the enablers that enjoy revenue growth from increasing content growth per vehicle.