Featured insights

Brian Levitt:

Welcome to the Greater Possibilities Podcast from Invesco, where we put concerns into context and opportunities into focus. I’m Brian Levitt.

Jodi Phillips:

And I’m Jodi Phillips. This is the second in a two-part series with Justin Livengood, a senior portfolio manager for the Invesco Midcap Growth Strategy, and a senior research analyst for our discovery and capital appreciation strategies. Justin’s focus is on financials, real estate, and healthcare. If you missed the first part of our conversation, we focused on the state of the US banking system. Now, we’re going to talk about market concentration, artificial intelligence, and more.

Jodi Phillips:

So, Brian, where do you want to start? Should we want to start with market concentration? I know that's been a huge topic of discussion and talk to Justin about what it might take for that to broaden at some point.

Brian Levitt:

I do, and Justin had talked about how smaller and mid-cap businesses have been participating more. It felt to me like we saw a lot of performance in November and December in small and mid-cap, and maybe it's become a little bit more concentrated again as we sit here at the end of February. And so why is that the case and how long can this persist?

Justin Livengood:

Yeah, so the rally you saw in small caps, particularly in November, December, was all about interest rates. That was when (Federal Reserve Chair Jay) Powell was-

Brian Levitt:

Yeah, fixed cuts.

Justin Livengood:

Right. Rates were peaking. He said, "We're done raising rates." Effectively. And there was this perhaps understandable swing in the pendulum to, "Oh gosh, the Fed's on the verge now of cutting." And that's going to be great because undeniably small cap companies are...

Brian Levitt:

Can I let you in on a little secret?

Justin Livengood:

Okay.

Brian Levitt:

When you do what I do for a living, you write outlooks in September and October and they come out in December, and we wrote Fed's going to lower interest rates this many times. That sets the stage for a really nice backdrop for small and midcap, and then it all happens in eight weeks.

Justin Livengood:

That's right. Then you're like-

Brian Levitt:

Do you feel bad for a guy like me or it's just part of my job?

Justin Livengood:

I hear you. Well listen, I feel your pain. Well, I don't. I sort of do because that was a tough relative time for us. I'm totally going off script, I don't even know if we're still rolling here, but when November and December happened, you had not just a small cap rally, but it was a pronounced rally by the weakest companies, the companies that were the most poorly financed, that looked like, "Okay, wow, they managed to survive. Now they're probably going to get bailed out by an accommodative Fed." And so lower quality businesses outperformed dramatically, and that's not helpful to the kind of investment process that we run. Having said that, the euphoria around the Fed pause and cut, hoped for cut, is what sparked that Q4 rally.

So what's happened in 2024 so far is first an awareness, a correct awareness that, "Hey, the Fed isn't about to cut. They are done raising rates in all likelihood, but they aren't about to cut any anytime soon." And then the second thing is you've had really good earnings from large cap companies. So we've largely finished Q4 earnings season and the high level statistics are telling. Small cap earnings, Russell 2000 earnings in the fourth quarter were negative, slightly negative as a overall group. Midcap earnings were slightly positive. Large cap S&P 500 earnings are tracking almost up 10%. So large cap again, and this is a trend that was persistent through much of last year, is winning in terms of earnings growth. And at the end of the day, earnings often, if not always move stocks and move valuations.

Now within that large cap earnings growth number, a lot of it was the largest companies. So one of the other questions that I know we're going to address is market breadth, and I'll just continue my prior illustration. Roughly a third of the S&P 500's market cap is in the top 10 companies. 50% of that earnings growth in Q4 was from the top 10 companies. So the big guys, the NVIDIAs and the Microsofts, they came through with excellent results and powered that outperformance and the stocks followed. And that's why we're looking at a lot of, and it's not just by the way, tech companies, Eli Lilly is up 25% year to date, Visa and MasterCard are up a ton, had great quarters. The other companies in the top 10 are doing well. It's not just the tech companies.

Brian Levitt:

So it's an AI market and a weight loss market?

Justin Livengood:

Those are two of the big things. Those seem like huge things that could materially change the U.S. economy.

Brian Levitt:

You're laughing? They're huge.

Justin Livengood:

Now in technology, there's a lot going on in addition to AI. AI's, I think, taking a lot of attention and somewhat deserved, but Microsoft and Amazon's cloud businesses are doing well for a lot of reasons, not just artificial intelligence. The semiconductor industry is doing well in part because of all the activity around NVIDIA and investments in AI, but in part for a lot of other reasons. And so it is a little more, I think, diversified on the technology side than perhaps the headline suggests. But away from that, the healthcare sector right now is absolutely being affected by this emergence of the GLP-1 obesity drug class and its benefits for Novo Nordisk and Lilly, but it's got a lot of implications on the rest of the sector.

Brian Levitt:

Even consumer staples.

Justin Livengood:

Absolutely.

Brian Levitt:

If you're not going to snack as much.

Justin Livengood:

Food companies, restaurant companies for sure, for sure.

Brian Levitt:

Yeah.

Justin Livengood:

So there's a lot of investing implications as it relates to that, but then there's just good solid things going on. I mentioned Visa, MasterCard, people are traveling again. People are, even though they're maybe not spending quite as much as they used to, consumer behavior's still pretty good. The best part of the market year to date though, isn't tech, it's industrials, especially in the small, midcap sections of the market. Industrials are thriving. There are some great, great, great industrial businesses. There's this whole trend of reshoring, we're having a lot of jobs and a lot of companies bring back projects and bring back work to the United States from the Middle East, and from Asia, and China. There's a lot of infrastructure investing going on partly because of AI and the cloud, but even partly just more basic and traditional infrastructure. So there's a lot of the industrial ecosystem that is thriving right now.

Orders are great. Some of our favorite companies in our funds, small, mid and large cap are industrials. They're not tech, they're not health care. And so it's fairly broad. So I'm happy to see that, but it's still tilted back to your original question, a little bit up cap right now. I do think though, as soon as we get a little further through this Fed pause, you're going to see that small cap and to some degree, midcap, performance perk back up. Perhaps not as much as we saw in the fourth quarter last year, but I think you'll see the rest of the market close the gap with those biggest companies

 Jodi Phillips:

Justin, you did touch on this, but I did want to ask a little bit about AI in the longer term, but in terms of companies that are using it, not the tech companiesthat are enabling it, but the companies that are using it in the longer term. You did talk a little bit about health care, but what about the intersection of, for example, AI in health care, or is that too much of a regulatory question, privacy questions? What are you looking at in terms of keeping an eye on the longer term ways that AI can fuel the other industries that you cover?

Justin Livengood:

Absolutely. So I got several comments on that. I'll start with health care. It's a little unclear how much AI is going to impact drug development in the near term for some of the reasons you just listed, Jodi. The big pharma companies and the biotech companies are dabbling in it, they're using it, but it's going to be more, I think in early research and helping identify targets and benchtop science. It's not going to be useful as much in actually running in-person clinical trials, which still have to be done, I think in a more hands-on traditional way. So I think there will be applications, I think it will be helpful, but I'm not sure that's the use case that's going to be most visible to us, at least in the very near term.

I do think though, there are some emerging use cases that are really interesting. So I'll give you a couple of examples. The first is IBM on their earnings call, or maybe it was at a recent onference, but in the last six to eight weeks said that they were, through the investments they've made in artificial intelligence, able to reduce the headcount in their HR department from 700 to 70 people.

Brian Levitt:

Wow.

Justin Livengood:

So now they're further along than probably a lot of people, and I don't want to suggest everyone's going to be able to do that day one or year one, but that is a flex.

Brian Levitt:

I'm going to keep my job.

Justin Livengood:

I know. That's my first thought too. I'm like, "Wow."

Brian Levitt:

I got two kids getting ready for college.

Justin Livengood:

Just hang in there.

Brian Levitt:

Just two more years.

Justin Livengood:

Just a few more years. That's all you need, Brian. So don't go work for IBM is my point. Yes. Stay here. So there's an example though of a very real use case that is clearly helping IBM's bottom line. However, they had to make investments upfront to get there. And I think the other thing that needs to be considered is a lot of other companies are earlier in their AI journey and trying to figure out where to make those investments. And one such example is Moody's, a company that I know well that's actually headquartered right across the street from us here in Lower Manhattan. Well, they reported earnings last week that were excellent. However, they guided 2024 expenses well above all of our expectations entirely because of investments they feel they now need to make in that analytics business targeted on artificial intelligence.

They see a lot of things, use cases that they think their clients are going to want, but to get there, they're going to have to spend a lot and they're pulling forward a lot of different projects into 2024 because they feel some urgency. So there is a bit of a back and forth. Whenever AI comes up in an investment discussion, everyone wants to look at the semiconductor companies and NVIDIA and, "Oh, this is all great." Well, on the other side, somebody's got to be actually writing the checks and spending the money. And not everybody's IBM, not everybody's already gotten to the point where they're seeing the rewards of those investments. We're actually in a lot of cases still early in the process of figuring out, "Okay, I know I need to be doing something, what do I do?" And so there's going to be more of the Moody's like updates I think, over the course of this year, which is fine. I think investors just need to be prepared for this to be a pretty big theme, an investment consideration as the year plays out.

Brian Levitt:

I get excited just hearing you talk about it. And so as we come to the end of this podcast, just talk a little bit about the opportunity cost of not being involved in markets, not being involved in the growth companies that you look at over the next couple of years or even beyond.

Justin Livengood:

Yeah, and I'd start by saying there's been disruption in the markets for a while.

Brian Levitt:

Forever.

Justin Livengood:

Forever.

Brian Levitt:

I'd hope so.

Justin Livengood:

But even we were talking before the podcast, Brian, about how growth has done really well as a category for over a decade. Well, a lot of that is explained by companies disrupting various industries, many of them technology, but also health care and industrials and the like. So there's been disruptive opportunity to capture and invest in for a long time. It just happens that right now, two of the more prominent things happening are artificial intelligence, and then in health care I would agree, this whole obesity dynamic and they're getting more attention and they're arguably driving a little bit more value creation than some other types of disruption in the last 10 to 15 years.

But there's always really interesting secular growth opportunity to participate in, and I think I've mentioned this with you in the past, and I referenced it a second ago when I was talking about industrials. It's not just the stuff on the headline. So when I come to work, whether it's in the office or at home, I'm not thinking about NVIDIA and AI and a lot of the big cap stocks very much. I'm spending a lot more time thinking about companies that most people listening to this podcast will have never heard of that are either benefiting from some of these themes or that are just in their own unique little opportunities and disruptive situations, but that are thriving. I can think of dozens and dozens of companies in the last few years that have gone from 2, 3, 4 billion in market cap to 15 or $15 billion companies that have gone to 30. And the speed with which this is happening is increasing a little bit the Moore's law kind of concept.

 Ron Zibelli, my boss and longtime colleague, loves to talk about this. He's like, "The pace of disruption is only increasing." And so you're seeing more and more companies taking advantage of that, that are not on the main playing field. They're off on one of the side fields, but they're still really, really exciting companies. So you go through the last two, three year period where the macro environment was extra volatile and sometimes that gets in the way of the stock performance of some of these really interesting secular stories because you've got to worry about what the Fed's doing and pandemics, and that's all understandable. But now that we've seen hopefully, the world calm down a little bit-

Brian Levitt:

Back to basics.

Justin Livengood: 

Right. The Fed has gotten inflation somewhat under control. We seem to be in a little bit more of an equilibrium long-term macro wise. I think it's going to allow those really interesting disruptors, those really interesting secular companies to again, shine. And that's partly why you're seeing growth continue to outperform. That's why sitting here today at the end of February, the NASDAQ and the S&P are up almost 7% already this year, and you tear that apart, that's mostly these higher growth disruptive companies that have just continued what they were already doing for much of 2023. It’s been a really interesting group to invest in, and I think there's definitely going to be opportunities going forward. So I would strongly encourage people not to try and time the market, especially in this part of the market where there's so much long-term opportunity.

Brian Levitt:

Jodi, as you know, I've been taking copious notes, so when we come back six months or a year from now with Justin, I will read that back to him and once again, hopefully he will tell us, "I feel very good about what I said."

Jodi Phillips:

That's right, that's right. We'll definitely have him on again, and hopefully there doesn't need to be a bank concern or bank issues to do it.

Brian Levitt:

Yeah. No crises.

Justin Livengood: 

Yeah. Hopefully, it won't be a crisis that is required for me to be here.

Jodi Phillips:

No, not at all.

Brian Levitt:

Thanks so much for being here.

Justin Livengood:

Thank you.

Jodi Phillips:

So Brian, where can our listeners find more market commentary from you?

Brian Levitt:

Well, Jodi, as always, visit invesco.com/brianlevitt to read my latest commentaries, and of course you can follow me on LinkedIn and on X at Brian Levitt.

 

Important information

You've been listening to Invesco's Greater Possibilities Podcast.

The opinions expressed are those of the speakers, are based on current market conditions as of February 27, 2024, and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.

Invesco is not affiliated with any of the companies or individuals mentioned herein.

This does not constitute a recommendation of any investment strategy or product for a particular investor. Investors should consult a financial professional before making any investment decisions.

Should this contain any forward looking statements, understand they are not guarantees of future results. They involve risks, uncertainties, and assumptions. There can be no assurance that actual results will not differ materially from expectations.

All investing involves risk, including the risk of loss.

Past performance is not a guarantee of future results.

Diversification does not guarantee a profit or eliminate the risk of loss.

An investment cannot be made directly in an index.

All data provided by Invesco unless otherwise noted.

In general, stock values fluctuate, sometimes widely, in response to activities specific to the company as well as general market, economic and political conditions.

Investments in financial institutions may be subject to certain risks, including the risk of regulatory actions, changes in interest rates and concentration of loan portfolios in an industry or sector.

The profitability of businesses in the financial services sector depends on the availability and cost of money and may fluctuate significantly in response to changes in government regulation, interest rates and general economic conditions. These businesses often operate with substantial financial leverage.

Growth stocks tend to be more sensitive to changes in their earnings and can be more volatile.

The health care industry is subject to risks relating to government regulation, obsolescence caused by scientific advances and technological innovations.

Investments in real estate related instruments may be affected by economic, legal, or environmental factors that affect property values, rents or occupancies of real estate. Real estate companies, including REITs or similar structures, tend to be small and mid-cap companies and their shares may be more volatile and less liquid.

Stocks of small and mid-sized companies tend to be more vulnerable to adverse developments, may be more volatile, and may be illiquid or restricted as to resale.

Many products and services offered in technology-related industries are subject to rapid obsolescence, which may lower the value of the issuers.

Investments focused in a particular sector, such as industrials, are subject to greater risk, and are more greatly impacted by market volatility, than more diversified investments.

References to small and mid-cap performance sourced from Bloomberg. Based on performance of the Russell 2000 and Russell Mid Cap indexes in November and December 2023.

References to lower quality businesses outperforming in the fourth quarter sourced from Bloomberg, based on quality metrics as defined by FTSE Russell.

References to the earnings growth of the Russell 2000 Index, the Russell Mid Cap Index and the S&P 500 Index sourced from Bloomberg.

The percent of the S&P 500’s market cap in the top 10 companies sourced from Bloomberg.

Performance of Eli Lilly, Visa and Mastercard sourced from Bloomberg as of February 27, 2024.

Comments about the performance of the industrials sector sourced from Bloomberg, based on the sector’s performance of the Russell Mid Cap Index and Russell 2000 Index.

Nasdaq Index and S&P 500 Index performance year-to-date through February 2024 sourced from Bloomberg.

The statement that growth has done well for a decade sourced from Bloomberg, based on the returns of the Russell 3000 Growth Index versus the Russell 3000 Value Index.

The Russell 2000® Index, a trademark/service mark of the Frank Russell Co.®, is an unmanaged index considered representative of small-cap stocks.

The Russell Midcap® Index is an unmanaged index considered representative of mid-cap stocks.

The Russell 3000® Growth Index is an unmanaged index considered representative of US growth stocks.

The Russell 3000® Value Index is an unmanaged index considered representative of US value stocks.

All Russell indexes mentioned are trademarks of the Frank Russell Co.

Moore's Law states that the number of transistors on a microchip doubles about every two years with a minimal cost increase.

The Greater Possibilities podcast is brought to you by Invesco Distributors, Inc.