Republican Speaker Kevin McCarthy told party colleagues that “we are nowhere near a deal yet,” according to Punchbowl News. Investors have also become less optimistic that the Federal Reserve will be prepared to cut rates later in the year, after business activity and housing market data suggested the economy may not be cooling as quickly as expected.
Despite the uncertainty, equity markets are still pricing a high probability of a rosy economic outcome in the near term. The S&P 500 is trading on 18.5 times 12 months forecast earnings, a roughly 14% premium to the average over the past decade. This reinforces our view that the near-term upside for equities, especially in the US, remains limited.
But investors shouldn’t lose sight of the potential for a secular bull base as the decade proceeds, comparable to the “Roaring 1920s”—with sustained growth above 2%, falling inflation, strong employment gains, rapidly rising productivity, and revolutionary technological change. We believe several supportive factors are in place that could contribute to such an outcome:
For the first time in 15 years, a substantial capital expenditure cycle appears to be underway. Bank of America estimates that manufacturing capital expenditure will reach USD 850bn in 2025, up 60% from the 2019 pre pandemic peak of USD 532bn, while McKinsey estimates that announced or underway investment in semiconductor fabrication plants is USD 180bn, with upwards of another USD 80bn under consideration.This outlook was supported by first quarter earnings statements, in which many companies indicated that capital spending was on the rise.
Growth capital is likely to remain abundant. Pitchbook reports that US venture capital (VC) investments—one proxy for access to growth capital—totaled about USD 97bn in the fourth quarter of 2022 and the first quarter of 2023 combined, roughly the same amount as in the fourth quarter of 2021 by itself. But the USD 54bn of investments in the first quarter of 2023 was still higher than in every quarter prior to 2021.
In addition, US VC and growth funds raised USD 160bn in 2022, more than the USD 152bn in 2021. Although the amount is down quite a bit so far in 2023—in part because companies are reluctant to accept additional funding at lower valuations than in prior rounds, while VCs are willing to hold off waiting for better terms—we expect this stand-off will eventually end, helping to unleash more capital.
An acceleration of digitization appears to be under way. The pandemic demonstrated that companies can deploy technology to efficiently run their businesses in ways once thought inconceivable. The release of ChatGPT in November 2022 has since accelerated the pace of digitalizing business models—the application had over 1 million users after five days, an unprecedented rate of adoption, and over 100 million estimated users now, according to data from analytics firm, Similarweb.
By bringing AI to the masses in an accessible and intuitive way, ChatGPT has unleashed the potential for AI to create new business models, similar to what the release of Netscape Navigator in 1994 did for the internet. Companies are responding to this opportunity, with IT spending growing much faster than general capex.
So, while investors should position selectively in the near term, in our view, preferring fixed income to equities over a tactical horizon, we advise keeping an eye on longer-term secular trends. A secular bull case scenario of elevated growth, rapid productivity gains, and falling inflation that seemed implausible a year and a half ago and even last summer now at least looks achievable.
Main contributors - Solita Marcelli, Mark Haefele, Jason Draho, Christopher Swann, Jon Gordon
Content is a product of the Chief Investment Office (CIO).
Original report - Roaring ‘20s remains possible despite headwinds, 24 May 2023.