The Silicon Valley Bus Tour
Jennison Associates provides thought-provoking insight on the evolving AI landscape and growth equity themes.
The U.S. economy stands in better shape than we anticipated when the year began. Robust employment has sustained consumer spending at a solid pace. Consumer confidence currently reflects optimism in the near term despite announced workforce reductions, interest rates at the highest levels in over a decade, and reduced credit availability in the financial system. It therefore seems likely that the slope of the economy’s slowing trajectory will remain shallower while employment remains healthy.
Sentiment in the near term is clouded by uncertainties due to—but not limited to—repeated threats of a government shutdown, auto strikes, the restart of student loan repayments, and the lagged effect on financing costs and spending intentions from interest rates that are at 15-year highs. These impediments will likely weigh on economic growth into year-end and deepen the deceleration that we have been anticipating since the year began.
U.S. consumers, with less robust prospects overall, are beginning to show stress—primarily at lower income levels. Overall, a healthy employment backdrop and residential real estate strength, which bolsters net worth, are variables that point to a moderate slowdown. As it relates to consumer-oriented companies, we believe those that remain tightly focused on leading brands, retailers, and service providers are best positioned to take wallet share and grow revenues and profits on a multi-year basis.
Technology spending trends have turned to cost optimization, rationalization of past customer investments to drive efficiencies, and headcount reductions. We are now more than a year into this environment and believe we will begin to see greater stability in spending activity and investment intentions moving into 2024. The broad categories of cloud adoption, data mining and analytics, and the still-nascent development and adoption of generative artificial intelligence (AI) capabilities remain at the forefront of longer-term investment plans across a wide range of industries.
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, large total addressable markets (TAM), and faster organic growth with long runways of opportunity.
Slowing global economies call for the resilience that healthcare companies can offer, yet the sector remains at a 10% discount to global equity markets compared to an average premium of 3% over the past two decades. We believe several factors will drive relative results across multiple healthcare industries.
Innovation and spending across drug development, genetic sequencing, data collection, and healthcare service delivery is accelerating and has continued to increase post-COVID. We’ve seen an unprecedented level of development aimed at some of the world’s largest total addressable markets, including diabetes, obesity, cardiovascular disease, and cancer. These advancements are creating new opportunities among select pharmaceutical companies that have the depth of resources—including large balance sheets and sizeable manpower—to capitalize on this enormous market for cardiovascular treatments and prevention.
The sector’s focus continues to be directed toward liquidity and duration differences between a given bank’s assets (loans, securities) and liabilities (deposits and term funding). In addition to liquidity, we believe another key risk to banking health is the status of loan quality. Banks carry significant exposure to commercial real estate (CRE), which is experiencing significant secular (post Covid) and cyclical challenges. As this economic cycle potentially turns, asset quality will need to be watched closely.
Future income statement pressure will come from continued labor cost pressures, but this is being offset by improved tech-driven efficiencies and generally better overall operation of the businesses by management. Nevertheless, the market is less concerned with these dynamics and is solely focused on the expectation of a future economic slowdown and the course of Fed tightening.
The energy sector has roared back recently, driven by an almost 30% gain in oil prices.
The group is well-positioned both near and long term, generating above-average cash flow yields yet trading at a significant valuation discount to the broader market. We think this disconnect presents an opportunity given the significant transformation in the sector over the last few years. We believe the capital discipline shown by management teams will continue, the sector will remain free cash flow positive, and companies will continue to return capital to shareholders. Earnings results have been strong, and share buybacks continue to provide stock valuation support.
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 commodities but for the essential logistical systems that move them.
Even during the economic volatility of the past few years, utility companies have continued to execute operationally and deliver strong earnings, while also de-risking 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, continued recessionary concerns and a flattening yield curve remain tailwinds. Strong fundamentals and macro factors underscore the opportunity in the sector, especially given what remains a lower-than-average interest rate environment even when considering the recent run-up in rates.
As the global investment landscape continues to evolve, our focus on finding innovative companies naturally uncovers disruptive themes over time. Below are secular themes we see offering compelling growth opportunities based on our bottom-up research.
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