Economy, AI Are Among the Key Themes for Growth Equities

In Brief

As 2024 begins, a combination of slowing inflation, stabilizing interest rates, and slower, but still solid, economic growth could favor growth equities.
Another encouraging factor is the prospect of improvement in market breadth and market leadership beyond mega-cap stocks, as investors recognize the potential in smaller-cap names.
In the innovation space, the widespread adoption, and commercialization, of artificial intelligence, and its impact on related technology offerings, is just one of several promising themes for 2024.

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As we enter 2024, we believe three key macroeconomic drivers—disinflation, rate stabilization, and moderation of economic growth—will lead to a stronger backdrop for equities, particularly for high-growth areas of the market and small cap stocks. In our view, disinflation is underway and will continue to trend in that direction through the next year as shelter and goods prices (e.g., used cars) should continue to exert disinflationary pressure. While it is too early to declare victory, we believe the U.S. Federal Reserve (Fed) is at the end of the rate hike cycle and, as a result, we will see more rate stability.

This, in turn, should be a tailwind for risk assets, particularly in those areas of the market that are lower in market capitalization and perceived to be long duration in nature. Lastly, we expect to see a normalization of economic growth as consumers and corporations recalibrate to higher interest rates than what we have seen over the prior decade. Lower economic growth favors stocks of those companies that grow with predictable revenue and resilient earnings. Investors tend to place a premium on those firms that exhibit the ability to increase revenues and profits irrespective of sluggish economic growth.

One of the defining features of 2023 was the outperformance of mega cap stocks, otherwise known as the “Magnificent Seven” (Nvidia, Meta, Tesla, Amazon, Alphabet, Apple, Microsoft). This cohort accounted for nearly 65% of the returns of the Russell 1000^® Growth Index over 2023, based on data from FactSet. As we shift to an environment of monetary policy easing, we expect to continue to see an improvement in market breadth and market leadership beyond mega cap stocks. In particular, we believe small capitalization stocks, which fared far worse than their large cap counterparts over the prior year, are poised to continue to rebound into 2024. The relief in Treasury yields since late October as well as the Fed’s dovish policy pivot in early December, led to a rally in small caps. From October 19, 2023, through December 21, 2023, the Russell 2000^® Growth Index was up nearly 15.5% while the Russell 1000^® Growth Index gained approximately 11.8%.

With the decreasing probability of a “hard landing” for the U.S. economy and a more benign monetary policy environment in 2024, the set-up for small cap stocks looks increasingly attractive. From a valuation standpoint, the Russell 2000 Growth Index is trading at levels not seen in over a decade when compared to the Russell 1000 Growth Index (see Figure 1).

Figure 1. Small Cap Valuations Set to Start 2024 at Attractive Levels

Ratio of the trailing 12-month P/E of the Russell 2000^® Growth Index to that of the Russell 1000^® Growth Index, December 31, 2013–December 20, 2023

Source: Bloomberg. Excludes stocks of companies with negative earnings. P/E = price-to-earnings ratio. The Russell 2000 Growth Index (R2KG) is a subset of the Russell 2000 Index, a widely followed benchmark for small-cap stocks. The Russell 1000 Growth Index (R1KG) is a subset of the Russell 1000 Index, which represents larger-capitalization stocks. For more information, see Glossary & Index Definitions, below.
For illustrative purposes only and does not represent any specific portfolio managed by Lord Abbett. Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment.
Past performance is not a reliable indicator or guarantee of future results.

Lastly, we believe the rapid pace of innovation, highlighted by the collapse in time of adoption curves for new technologies, favors businesses led by exceptional management teams with a willingness to embrace, and adapt to, change. Secular forces at play are providing attractive long-term growth potential. These include, but are not limited to:

the artificial intelligence revolution and the resulting demand for semiconductor and software products
the continued shift from offline consumption to online services, driving demand for e-commerce and digital media
the proliferation of, and improved use cases within, medical devices
breakthroughs in genomics and biotechnology
a sustained improvement in the structural growth rate of the industrial complex

Despite the normalization of growth, we believe the operating landscape will mark a departure from the prior decade of chronically low inflation and negative real (inflation-adjusted) interest rates. And while we expect select companies to thrive amid this backdrop, the new environment will likely pose challenges to less agile businesses. Management teams and market participants alike will have to adapt to this new environment where fundamental analysis will become increasingly critical to identify the winners and avoid the losers.

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About the Contributors

Matthew R. DeCicco, CFA

Partner & Director of Equities

Melanie Coffin, CFA

Institutional Relationship Director

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Price-to-Earnings Ratio: Stock analysts calculate a price-to-earnings ratio by dividing a stock's current price by its earnings per share on a trailing 12-month basis. A forward price-to-earnings ratio is calculated by dividing a stock's current price by estimated future earnings per share.

The U.S. Federal Reserve (Fed) is the central bank of the United States. The federal funds (fed funds) rate is the target interest rate set by the Fed at which commercial banks borrow and lend their excess reserves to each other overnight.

The Russell 1000 Index^® measures the performance of the 1,000 largest companies in the Russell 3000 Index, which represents approximately 92% of the total market capitalization of the Russell 3000 Index.

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