Karen Firestone: After the S&P 500’s wild ride, here are the sectors to watch in 2024

Published Wed, Jan 3 20242:19 PM ESTUpdated Wed, Jan 3 20243:16 PM EST

After the S & P 500 surged 24.2% in 2023, the question now facing investors is, "What can keep this uptrend in place?" Last month, we discussed the importance of a broadening of the market beyond the mega-cap technology and communications stocks that dominated 2023. The table below illustrates how the Invesco S & P 500 Equal Weight ETF (RSP) and the industrial and financial sectors outperformed the S & P 500 in December. We are currently exploring new ideas in the industrial, financial and health-care sectors. As the post-Covid world continues to normalize, the more mundane corporate universe should stabilize and attract more attention. Sectors to watch in 2024 We will be watching how financials, industrials and health care — three groups that underperformed the S & P 500 last year — will be treated by investors in 2024. Financials and industrials have recently rallied, buoyed by soft landing expectations. Health care remains weak, other than biotech acquisitions and a few powerful drug-specific cases, such as weight loss products at Novo Nordisk and Eli Lilly . Below is a table that shows the average 2024 price to earnings for the largest components in these sectors. The valuations for both financials and health care appear very attractive, although that has been true for years. We need to see a boost in earnings, at least by 2025, to drive these groups higher. Deal flow is a catalyst for banking commissions, and mergers and acquisitions in biopharma could ignite interest in the stocks. While a recession is a recipe for distress in financial services, a soft landing is a heavenly gift, by comparison. Last year's bank failures shattered any enthusiasm for the group, but investors looking for "cheap" can stop right here if that's their trigger point. The top of the sector — JPMorgan , Bank of America , Morgan Stanley and Goldman Sachs — trades at an average multiple on 2024 earnings of 11.6. Within the industrials, the picture is similar, with anticipated slow to minimal growth in 2024 and low valuations for the largest participants, such as Caterpillar and Deere . However, global demand could surprise analysts and propel earnings above estimates. The anti-global theme has weighed heavily on the group through most of 2023. Nevertheless, this could represent a buying opportunity if these tendencies are overcome by price, availability and expertise of foreign suppliers selling the best capital equipment. Health care has suffered from the lack of breakthrough medicines, other than the GLP-1 drugs, but pipelines are always a high-risk bet. Most of the major pharma companies, including Merck , Bristol Myers Squibb and Amgen , have a stable of high margin, slow growing drugs that sustain the research effort. There has been a multiyear dry spell in approvals of novel blockbusters, but after the enormous success of the weight loss drugs, clinical success and investors' cynicism could reverse. Another negative for the biopharma sector today is the fear of price controls. While any profit reduction hurts, the gross margin on all drugs is typically so high that they would remain very profitable. There is also room to reduce sales and marketing costs. The Magnificent Seven's influence The fate of the whole market is tied to that of the Magnificent Seven — Apple , Amazon , Alphabet , Nvidia , Meta Platforms , Microsoft and Tesla — which account for more than 28% of the S & P 500. What does it take for the market to push higher if these stocks decline in 2024? We have discussed how the mega caps have charted the course for the S & P 500 because of their tremendous absolute market values compared to the other stocks in the index. The tables below offer insight into the scope of moves other constituents need to make if the top dogs — Apple, Microsoft, Alphabet and Amazon — were to drop 5% just to maintain the market at its prior level. Since the four largest stocks represent 21% of the whole S & P 500, a decline of 5% equals over 1% of the total index. That might not sound like much, but it's still a heavy chunk of change. To fill the gap left in the S & P 500 if the big four were to drop 5%, these large-cap diverse names from Chevron to Morgan Stanley would each need to ascend an average of 25%. This is certainly possible, but these stocks need to generate sparks that attract investors, either in the form of multiple expansion or greater earnings expectations. Lower interest rates, a soft landing and expanded capital investment might provide these catalysts. Consider that 5% is not a huge slide for four stocks that rose, on average, by over 60% in 2023. What happens if the decline is 10%, or around $900 billion to recover, just to stay even? The math gets trickier, and the task becomes more challenging. On the other hand, the highest 2025 PE multiple among the Apple, Microsoft, Alphabet and Amazon gang of four, is 31, which is far less than stratospheric. What happens to these stocks and what will be their effect on the overall market sentiment are the most important questions to us right now. — Karen Firestone is chairperson, CEO and co-founder of Aureus Asset Management, an investment firm dedicated to providing contemporary asset management to families, individuals and institutions.