Investors should avoid trying to time the market with short-term trades or buying up broad index exposure as macroeconomic and geopolitical volatility combined with some lofty valuations could derail such strategies.
This is the view of Fabiana Fedeli, chief investment officer (CIO) for equities, multi asset and sustainability at M&G Investments, who thinks investors should be seeking out innovative companies that have so far stayed out of the headlines.
In M&G Investments’ mid-year outlook, Fedeli argued that equity markets still appear to be an attractive opportunity, thanks to a backdrop of resilient economic growth and the likelihood that interest rates have peaked.
Performance of global equities vs global bonds over 2024
Source: FE Analytics
But she also suggested investors adopt a selective approach to stocks. Looking at the first half of 2024, Fedeli said there were two key drivers for outperformance: a beat of earnings expectations (as in the case of European and Chinese stocks) and the successful delivery of innovation (seen among companies in the US tech sector).
“In cases where undemanding expectations met with the power to innovate, this created some of the strongest outperformance,” she said. “Going forward, this will continue to be among the best hunting grounds for the creation of alpha, in our view, with opportunities deriving from investors’ tendency to converge around a narrower set of brand names.”
However, the CIO cautioned against simply backing the companies that have already performed strongly, pointing to the so-called Magnificent Seven of Microsoft, Apple, Nvidia, Alphabet, Amazon, Meta and Tesla. While these companies were responsible for the bulk of the S&P 500’s gains in 2023, only Nvidia is among the top 40 best performing stocks in the world for 2024 to date.
Top 10 performers in the MSCI AC World over 2024
Source: M&G Investments, Bloomberg. Returns to 6 Jun 2024 in US dollars
Fedeli said: “We firmly believe in the power of innovation as a driver of business and investment returns. However, the valuations of many companies at the forefront of innovation have seen a spectacular rise over the past year. Some may still warrant further upside, but others may be due a pause for business fundamentals to catch up with investors’ excitement.
“This, however, does not mean that the equity market has exhausted its opportunities. To harness the transformative potential of innovation and new technologies from here, we believe investors need to look beyond the ‘headliners’ and seek opportunities across the wider market; across sectors and geographies. In a nutshell, we need to dig deeper and broaden our search.”
While Nvidia has been “the poster child for tech innovation” recently because of its importance to artificial intelligence (AI), M&G Investments argued there are other less-visible companies with innovative products and a competitive edge, highlighting five to prove its point.
First up is German multinational technology giant Siemens. It is overlooked by some investors as it can be difficult to identify the attractive business drivers of such massive conglomerates.
However, Fedeli said Siemens has “quietly transformed” itself from being a large industrial manufacturing company into “an industrial software and productivity colossus” through its factory automation business.
NTT might be best known as Japan’s largest telecommunications firm but not every investor appreciates its status as the world’s third largest data centre owner. It is also at the forefront of cutting-edge ‘photonics’ technology.
“As data creation and transmission increases exponentially, particularly as the use of AI becomes more ubiquitous, the processing of information using the company’s optical technologies has the potential to increase energy efficiency by a factor of 100 (as well as increasing transmission capacity by a factor of 125 and reducing latency by a factor of 200),” the CIO said.
M&G Investments thinks another Japanese company is the third hidden gem innovator: material sciences firm Toray. The AI revolution needs to be powered by more energy and, when put alongside the need to transition to clean energy, the obvious winners might be wind and solar farm operators.
However, Fedeli pointed to the fact that advanced composite materials and components supplied by the likes of Toray are essential to these projects. The firm produces around 50% of the composite material used to manufacture wind blades across the globe, as well the cutting edge carbon fibre used to make lighter, more fuel-efficient aircraft.
M&G Investments turned to China for an example of an innovative business in a less eye-catching part of the market. Hong Kong-based Crystal supplies technical materials to the likes of clothing brands Uniqlo and Lululemon; it is increasingly focusing on sustainable materials, production techniques and supply-chain traceability, leveraging emerging technologies such as large language models and generative AI to improve efficiencies throughout its value chain.
Finally, the asset management house found a hidden gem in the technology sector: German software solutions company SAP. The company is embedding AI in its software products and using it to bolster research & development projects, while transitioning its core enterprise solutions business to the cloud.
“There are more hidden gems across industries, including many that are starting to emerge in the financial and healthcare sectors,” Fedeli finished.
“If we go by recent earnings season results, with consumers and corporates making increasingly deliberate choices about where to spend, companies that are not only meeting their customers’ current needs but also improving their products and services to meet their future needs, have been able to beat market expectations and grow – even with the backdrop of higher-for-longer rates.”