Growth Stocks in Favor as The Economy Moderates
In its first quarter 2025 outlook, Jennison Associates outlines its positive outlook on the long-term prospects for resilient, durable growth stocks.
Resilient Growth Stocks to Thrive
We exit 2024 on the back of several strong years of share price recovery, particularly for growth stocks, following the sharp declines in late 2021 through 2022. The strength of corporate profits overall has been an important contributor amidst sustained growth of the U.S. economy. While the rate of inflation has continued to decline, trends have also flattened out in recent months. The path to lower short-term interest rates rests on the dynamics between these factors, and we have less clarity in direction at the end of 2024 than the beginning of the year.
Equity price appreciation has fared better than we initially expected through the first nine months of the year, and we have benefited from our focus on companies with above-average growth rates. We see this trend as likely to continue as the pace of economic activity moderates.
The effects of tariffs have also been much debated since the election. We do not doubt their likely use, though the degree and scope here also remain to be seen. Some argue that these measures need not prove inflationary if one-off in nature and buying preference shifts to lower-priced alternatives. Most of the economic theory would point to higher prices from tariffs as headwinds to growth regardless of their duration. The uncertainty over their impact likely compounds economic and market uncertainty in the near term. We would expect actions taken in this area to be amongst the first of the new administration. Back-channel discussions have already taken place between world leaders and the incoming administration, but there is little clarity at this stage.
Sector Views
During the quarter, mid- and large-cap growth stocks led in the fourth quarter, while value underperformed across market caps. Small caps, especially value, lagged for all longer times periods.
Meanwhile, there was significant disparity among sector returns in the fourth quarter. Consumer discretionary and communication services were the best-performing sectors. Materials and health care lost double digits.
Longer term, we believe the market will continue to favor companies with asset-light business models, high incremental gross profit margins, subscription model revenue streams, disruptive products with wide competitive moats, large total addressable markets (TAM) and faster organic growth with long and durable runways of opportunity.
Continuing the trend we saw throughout the year, the S&P 500 Index’s information technology sector was up 4.8% in the fourth quarter of 2024. This reflects continued better-than-expected fundamentals across a broad range of business models—mainly the AI leaders—along with an improving macroeconomic environment. We are also seeing ongoing improvement in inflation expectations as we transition into 2025. Finally, the recent U.S election and its future implications around lower taxes and less regulation has been an additional catalyst behind earnings growth expectations across a broad range of industries.
Fundamentals are being driven by the disruptive opportunity for AI and the digital transformation of the consumer and businesses, especially the mega-cap companies in the space who can invest heavily to stay ahead with respect to innovation and disruption. The longer-term underlying strength in these business models and their secular revenue/profit trends remain solid and were highlighted across the overall sector’s reported earnings these past few years.
AI and the super-high-speed computing processing that it requires continues to drive accelerating demand across a broad range of chip and silicon companies. This also includes the software architecture and application players and cloud platform leaders, along with the high-end design and manufacturing/fabrication providers. This also extends into these new AI data centers, and their unique demands for power consumption and control/distribution, along with cooling and signal processing, are contributing to rising demand. We would expect to see AI use cases and applications spread from technology providers and developers to a wide variety of industries and companies that use these tools to increase competitive positioning through improved time to market, streamlined customer service and accelerated efforts to harness data in increasingly sophisticated ways.
The S&P Composite 1500 Health Care Index (the Index) declined 9.8% in the fourth quarter, trailing the S&P 500, which gained 2.4%. Additionally, the Nasdaq Biotechnology Index declined 9.4%. Over the trailing 12 months, the health care sector’s 2.8% return trailed the overall Index’s 25.0% gain.
The sector’s recent underperformance, particularly in late 2024, has created a significant dislocation between perceived and intrinsic value. Despite the S&P 1500 Health Care Index’s relatively weak year-to-date return, which lagged broader market gains, the sector’s long-term fundamentals remain strong. The short-term uncertainty, exacerbated by political factors such as potential leadership changes at the Department of Health and Human Services, has led to a nearly 10% drop in health care stocks from September to December 2024. This market inefficiency can present an exceptional opportunity for skilled active managers to capitalize on the favorable risk-reward profile. As the market grapples with regulatory changes and evolving dynamics, we believe astute investors can identify undervalued assets, positioning themselves for potentially outsized returns as sentiment normalizes and valuations realign with the sector’s long-term growth prospects, driven by demographic trends and ongoing innovation.
The financials sector of the S&P 500 was up +30.6% vs. +25.0% for the overall S&P 500. This reflects continued better-than-expected fundamentals across a broad range of business models, along with improving credit conditions.
Another positive is the ongoing easing by the Federal Reserve. Commentary from Fed board members in the past months emphasized the need to remain vigilant in the ongoing process of fighting inflation while recognizing the solid trends towards their sub-2.0% target. At the same time, they acknowledged the lagging impacts of the rate increases of the past year that have yet to fully reveal themselves in economic growth.
Overall, the large money center, consumer finance, and superregional banks are significantly better positioned today across a broad range of balance sheet, capital, and risk management metrics. Valuations in the sector have normalized. We believe tailwinds for future earnings growth will be primarily driven by solid revenue trends and credit controls; growing net interest margins; ongoing expansion of their fee-based business opportunities; and continued efficiency improvements through better use of technology. We are also seeing opportunities with solid fundamentals and attractive valuations in global alternative asset management firms, P&C insurance companies, and several digital payment and financial technology companies.
For the full three-month period, the Alerian Midstream Energy Index (AMNA) was up 13.5%, outperforming the 2.4% return of the S&P 500. The less diversified Alerian MLP Index (AMZ) advanced 4.9%. Oil prices ended the year close to the levels at the beginning of the year, reiterating that OPEC+ will reassess supply quota increases if prices are too low.
Natural gas spiked off multi-year lows as seasonal electricity demand expectations along with the long-term need for new electricity generation will benefit natural gas—the most environmentally friendly fossil fuel. Long-term natural gas demand growth and high cash returns to shareholders remain positive tailwinds for the sector and recent bolt-on investment projects have the potential to drive accelerated cash flow growth over the next three to five years.
We believe that, over the longer term, midstream energy companies will play an important role in our energy future. The global energy transition will require multiple sources of energy to be successful and hydrocarbons—especially natural gas—will continue to have a role, driving future demand, not just for the commodities, but for the essential logistical systems that move them. With physical steel in the ground, midstream energy infrastructure companies have difficult-to-replicate asset networks with high barriers to entry, and whose adaptability to transport other energy sources is underappreciated. Management teams are increasingly aware of the role they will play in our energy future, focusing not just on the environmental impact of their operations but also on how their asset bases can and will be part of a greener future.
The utilities sector of the S&P 500 Index was down this quarter, underperforming the broader market. During the fourth quarter of 2024, rising interest rates and uncertainty regarding President-elect Trump’s intentions for federal renewable energy policy (including the Inflation Reduction Act) contributed to an investing backdrop for the U.S. utilities sector that skewed more challenging than during 3Q24. Additionally, rising investor expectations regarding potentially pro-cyclical legislation and policies from the incoming Trump-Vance administration paved the way for a reversal of 3Q24’s “safe haven” trade as the utilities sector underperformed the broader market in 4Q24. Continued investor enthusiasm for the strong outlook for generative AI-related data center power demand growth propelled shares of our names in the independent power producers (IPPs) and renewables segment as well as midstream energy holdings higher during 4Q24. This was driven by continued rising expectations for forward power prices, regulated utilities electricity load growth, renewable energy development activity and natural gas demand for gas-fired generation. We believe strong long-term fundamentals and still-reasonable valuations underscore the opportunity in the utilities sector. Utilities decreased by -5.5% in 4Q24, underperforming the 2.4% return of the S&P 500.
While absolute performance results were strong in 2024, the utilities sector was negative and experienced its worst relative performance in over 40 years in 2023 and the utilities sector has been one of the weakest sectors over the last five years. However, even during the economic volatility of the past few years, the companies in the sector have continued to execute operationally and deliver strong earnings while also derisking their portfolios. Continued solid execution, along with the potential growth opportunities from renewable energy investments, should help to drive the sector’s earnings going forward. In addition, despite investor volatility, the increase in power demand growth driven by AI presents both a challenge to meet that demand but also supports underlying earnings growth potential. Strong fundamentals and macro factors underscore the opportunity in the sector, especially given what remains a lower-than-average interest rate environment.
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Alerian Midstream Energy Index is a broad-based composite of North American energy infrastructure companies and is a capped, float-adjusted, capitalization-weighted index whose constituents earn the majority of their cash flow from midstream activities involving energy commodities. Alerian MLP Index is the leading gauge of energy infrastructure Master Limited Partnerships (MLPs) and is a capped, float-adjusted, capitalization-weighted index, whose constituents earn the majority of their cash flow from midstream activities involving energy commodities. Nasdaq Biotechnology Index contains securities of Nasdaq-listed companies classified according to the Industry Classification Benchmark as either Biotechnology or Pharmaceuticals which also meet other eligibility criteria. S&P 500 Index is an unmanaged index of 500 common stocks of large U.S. companies, weighted by market capitalization. It gives a broad look at how U.S. stock prices have performed. S&P 500 Financials Index comprises those companies included in the S&P 500 that are classified as members of the Global Industry Classification Standard (GICS) financials sector. S&P Composite 1500 Health Care Index comprises those companies included in the S&P Composite 1500 that are classified as members of the Global Industry Classification Standard (GICS) healthcare sector. S&P 500 Technology Index comprises those companies included in the S&P 500 that are classified as members of the Global Industry Classification Standard (GICS) technology sector. S&P 500 Utilities Index comprises those companies included in the S&P 500 that are classified as members of the Global Industry Classification Standard (GICS) utilities sector. Indices are unmanaged and an investment cannot be made directly into an index.
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