The calendar often marks what are somewhat arbitrary posts along an investor’s journey and the year just gone as a case in point. The fourth quarter of 2023 saw a sharp equity rally, as the market moved to resoundingly price in peak interest rates and sharper future cuts, reversing the “higher for longer” third quarter sell off. Taking a step back markets rarely move in straight lines and the process of finding peak rates, following the second sharpest tightening cycle on record, was always going to be a choppy one. The starting point also mattered as the stock market bottomed in October 2022, setting up 2023 naturally well after the preceding bear market. It is hard to remember but back then most commentators expected a recession in H2 2023 which never materialized. All these factors helped the markets and the final quarter’s backdrop was very positive for Tema’s funds and all of them put in a strong performance.
This period also saw the launch of the Tema Obesity & Cardiometabolic ETF (HRTS), Managed by veteran life sciences portfolio manager David Song, MD, PhD, CFA. HRTS builds on the obesity drug revolution by investing in the recent burst of innovation addressing cardiovascular disease, the number one cause of death globally1. Such innovation is attractively priced by the market after a torrid downcycle in the life sciences sector. This downcycle, the worst on record, is starting to show signs of ending, punctuated by a strong rally this past quarter, which, if history repeats, could have a long way to run.
As we look out to 2024, we thought it would be helpful to provide a few guiding principles, not predictions, of how we see things unfolding. These are grounded in what we are seeing bottom-up from analyzing and speaking to the companies we invest in, and somewhat contrast the market’s general consensus:
True Pricing Power to Shine Through – In 2022 most companies had an easy time raising prices as cost were often rising more rapidly. From the second half of 2023 onwards costs finally started to subside, creating a meaningful tailwind for margins. This dynamic was described by most analysts as pricing power. We think that as cost declines accelerate only firms with true pricing power will be able to hang on to or even raise prices further – a distinction that will be increasingly rewarded in 2024.
A Recession After All – Calling recessions is a fool’s errand, especially for long-term bottom-up investors. In recent years, however, it has been helpful to assess how the economic outlook stacks up against consensus views. Here we see risks in the second half of 2024 against a market that is strongly assuming a soft-landing. The tightening cycle will finally hit economic growth with its long and varied lags. Economic weakness is unlikely to be sharp, as there are simply not as many excesses as we have seen ahead of previous downturns. Regardless, markets move to price in recessions six months before they start suggesting a volatile year ahead.
Scarcity of Growth – In the face of a year of likely disappointing economic growth, investors will be left looking for other sources of growth. Here stocks exposed to megatrends become more valuable and I recommend reading our latest trend report to get a glimpse of areas we see as most promising. Reshoring for example could, as many management teams have highlighted, offset cyclical weakness in both sales growth and margins even in the most economically sensitive companies. Indeed, announced activity throughout 2023, including the exponential rise in manufacturing construction, will start to benefit firms in 2024 and beyond.
Need Diversification – It is no secret that the market in 2023 became a lot more concentrated. As we close out the year, seven stocks account for 30% of the total US market cap. Investors who think they own a diversified exposure are actually taking individual company risk in a group valued at 31x forward earnings. Diversification should serve investors well in 2024. This can be achieved for example from idiosyncratic return sources like biotech where scientific and clinical risks are uncorrelated to general market returns.