The Year Ahead for the Major Industry Sectors, Part 1

The first of two Perspectives outlining some of the key themes we think will drive the major industry sectors in 2024.

Each January, we ask our team of research analysts for their outlooks on the major industry sectors for the year ahead.

With the U.S. election coinciding with a likely economic slowdown and the potential for the first rate cuts since 2020, this looks set to be another eventful year. With that in mind, over the next two CIO Weekly Perspectives we will present some of those key themes from our analysts, starting with the Healthcare, Energy, and Power and Utilities sectors.

Healthcare Services: Election Politics and Rates

Ari Singh, our Healthcare Services analyst, thinks that the theme of the dominance of top-down forces is likely to continue from 2023 into 2024. Whereas last year was all about the impact of higher interest rates, however, this year will be about interest rates and U.S. election and policy expectations.

While the threat of major negative legislation is largely off the table, there are stark differences in the policy proposals of the two main candidates for the presidency and right now the outcome is too close to call.

The major difference is the likelihood of a Trump administration expanding Medicare Advantage reimbursements, which we think would benefit the healthcare services sector overall, but particularly those stocks geared to Medicare Advantage. As a domestically focused sector, Healthcare Services could also be a shelter from the trade policies of a Trump administration.

Certain stocks in the sector could benefit from Democratic policies on Medicaid, public insurance exchanges and expanding mental-health coverage, but they are fewer in number.

Therapeutics, Life Sciences & Tools and MedTech: Mean Reversion?

Apart from a couple of outstanding names, Therapeutics and Life Sciences & Tools underperformed during 2023. Might 2024 bring mean reversion?

Life Sciences & Tools, along with MedTech, are largely insulated from election risk, in our view. However, our analyst Terri Towers notes that it could be a key determinant for large-cap Therapeutics. Over time, changes planned under the Inflation Reduction Act (IRA) could pose a particular risk to manufacturers of Medicare “Part D” drugs, for example. Therapeutics generally underperforms amid the uncertainty of election years—so current outperformance may fade—but a Republican sweep in November could trigger a significant relief rally.

Beyond election risk, we have assessed various new Therapeutic categories. We think some, such as gene therapy/gene editing and antibody drug conjugates (ADCs) across the oncology landscape, could eventually be attractive markets, but will take time to gain traction. On the other hand, we anticipate continued explosive growth in the obesity drugs market, but also believe the currently out-of-favor market for Alzheimer’s treatments is approaching an inflection in the second half of the year.

Terri sees a more favorable outlook for Life Sciences & Tools. Lower rates and more M&A could benefit these growth-oriented and fragmented subsectors, coupled with a reset in expectations and more favorable earnings comparisons. While valuations are a little stretched in Core Tools, Contract Research Organizations (CROs), which could be due for re-rating, are an alternative subsector to consider for 2024.

Finally, our analyst Eric Boland has a positive view on the MedTech for this year, supported by strong surgical procedure trends. As well as being relatively insulated from election-year uncertainty, it is typically resilient in economic slowdowns and should benefit from easing input costs as the year progresses. The sector was hit by volatility associated with the perceived threat from obesity drugs last year, but we believe these concerns have receded considerably from their peak.

Energy: An Unexpected Glut

The Energy sector has had a rough start to the year due to concerns around too much supply and the slowing economy.

As our analyst Jeff Wyll observes, the oil supply surprise has come on two fronts. Geopolitical tensions have so far led to little actual disruption: Russian supply, in particular, has declined only modestly. Meanwhile, U.S. production has grown faster than expected—despite the welcome adoption of capital discipline at most of the public oil and gas producers, which have committed to slower growth and higher cash distributions. This reflects improvements in drilling efficiencies and possibly less capital discipline among privately owned producers.

This higher-than-expected production last year prompted further OPEC action to support prices, such as Saudi’s one-million-barrel-per-day output cut, which we expect to be extended in March. Along with heightened tensions in the Middle East, this has helped prop up oil prices above $70/bbl. While higher prices are a positive for the Energy sector, they also remove an incentive to slow U.S. production—and Jeff thinks the market needs to see that U.S. production slowdown to turn positive on the sector.

Natural gas prices have been volatile as North America’s warm December has given way to a colder January. However, our focus remains further out: Medium-term demand trends, particularly for U.S. liquefied natural gas (LNG) exports, could result in a supply deficit and higher prices in 2025 and beyond. We see this as an emerging theme.

Both oil and gas remain cyclical, with self-correcting mechanisms in place should prices undergo a more material move, up or down. In the meantime, valuations have become more attractive and Energy remains a hedge against escalating disruption in the Middle East. In our view, that warrants staying involved in the sector despite what now appears to be a mixed near-term outlook.

Power & Utilities: Energy Transition Remains Key

The energy-transition and electrification themes are dominant in the Power & Utilities sector, in our view, for 2024 and well beyond. They benefit both the cyclical Independent Power Producer (IPP) stocks and the defensive Utilities. Some trends represent a double acceleration of power demand: For example, electric vehicles are not only powered by electricity, but also require significantly more electricity to manufacture than traditional vehicles.

These themes are, in turn, influenced by the IRA, which could be under threat in the event of a Republican win in November—although we note that this vulnerability may be overstated, as a lot of IRA spending is directed at Republican or swing states.

Elsewhere, we anticipate some clarification of the U.S. rules governing the hydrogen market this year and would view that as a likely catalyst to accelerate hydrogen activity in the sector. We think that some power markets, such as Texas, are much tighter than investors are priced for; and, as mentioned already, we see a 2025 tailwind in rising demand for U.S. LNG.

Another emerging theme is the artificial intelligence (AI) revolution: New data centers are upwards of five times more power-hungry than recent vintages. Power requirements for AI-related demand may lead to significant challenges for power suppliers. We think this supply-demand imbalance should be an important focus in the coming years for investors, companies, regulators and policymakers.

All that said, we see the economic slowdown as a major risk to the sector in 2024, and for that reason our sector analyst Ronald Silvestri suggests a “barbell” of defensive Utilities and cyclical Pipeline Operators and IPPs (or a focus on one side or the other if you have a strong macroeconomic view).

Utilities endured their worst underperformance in 40 years in 2023 as rates shot up and investors shunned defensive stocks. Valuations are attractive, consolidation is a possibility and the energy-transition opportunity set is substantial, in our view—but selectivity is important, particularly with regard to state-level regulatory risk.

IPPs appear reasonably valued to us, and balance high free-cash-flow generation and leverage to the electrification theme with commodity-price exposure. Pipelines also carry commodity-price exposure, but we believe they are cushioned by increasing capital discipline, strong balance sheets and relatively attractive valuations—and the favorable longer-term outlook for natural gas demand.

An Eventful Year Ahead

Important idiosyncratic and sector-specific risks are present among these themes—the gene-therapy safety issue in Therapeutics, for example, production cuts in Energy and state regulation in Utilities. But macroeconomic and political risk is set to be elevated in the year ahead, so it is no surprise that we expect differing exposures to those risks to be a key determinant of our outlooks on individual stocks’ earnings and performance.

Look out for next Monday’s Perspectives, where we will reflect on what 2024 holds for the Technology, Industrial, Consumer and Financial sectors.