Chief Investment Strategist
Summary: Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
A benign economic backdrop combined with investor excitement over generative artificial intelligence (AI) and the new class of obesity drugs from Eli Lilly and Novo Nordisk have set in motion a speculative fever. The result is nothing but stunning. In no time, Nvidia has been catapulted to become the third most valuable company in the US worth $2.2trn and Novo Nordisk has become Europe’s most valuable company worth $600bn. Next to these stories there is an entire ecosystem of AI related companies, and obesity and biotechnology companies thriving on this boom in innovation. And not to forget the Magnificent Seven
Excitement always drive greed and extrapolation of expectations to unsustainable levels. This time is no different. As of February 2024, the US equity market hit valuation levels not seen since the dot-com and 2021 technology bubbles. Historically, the current equity valuation has led to low equity returns after subtracting inflation over the subsequent 10 years. Since December 2021, US equities are only up 5.2% and US CPI Index is up 10.6% as of January 2024. With US equities at their current equity valuations it is not the time to get greedy. In fact, investors should think about reducing their US equity exposure. Of course, we could be horribly wrong and the rubber band stretches even further.
The stretched valuation in US equities makes us tactically go neutral against a strategically positive view on US equities. While many negative things can be said of Europe the fiscal valves are being opened and the European equity market has some catchup to do relative to US and Japanese equities so our view is that a geography rotation into Europe could happen in Q2. We maintain negative view short term on Japanese equities due to JPY risks and BoJ pivot on policy rate.
On a sector level we are positive on energy (great value and good inflation hedge), health care (strong growth relative to valuation), and financials (favourable valuation and still good operating environment). We are negative on industrials (low growth and expensive), information technology (too much speculation and hype in the short term), utilities (low momentum and negative outlook), and real estate (low momentum and expensive).
This year is biggest election year in modern history with the US election on 5 November being the most important election and especially for Europe. Biden and Trump are polling on par for the general election in the two most recent large polls, and Trump is questioning NATO and military support for Europe, keeping European politicians anxious with a more assertive Russia.
Regardless of whether Trump wins or not his comments about NATO have set off alarm bells in Europe’s capitals and mobilized efforts to dramatically increase military spending. Poland is already spending 4% of GDP and is willing to spend more. With military spending targets presented in Europe to go well beyond 2% of GDP a lot of growth is coming “Europe first” military spending benefitting European defence companies. Rheinmetall, Germany’s largest defence company, is expected to grow revenue by at least 18% annualised over the next five years. One of our biggest convictions is European defence companies.
How can investors get exposure to defence stocks? Investors can get inspiration from our defence theme basket or check out the various ETFs such as Future of Defence UCITS ETF or VanEck Defence UCITS ETF.
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