By Paul Vincent, manager of the Ninety One American Franchise fund
Blue Monday, the mythical day in January when the post-Christmas cheer has evaporated, the weather turns into a polar blast, and the resolve to stick to New Year’s resolutions is already crumbling. For some investors, there may be a sense of gloom having missed out on the full gains of the US equity market outperformance in 2024.
However, despite the potential for the US’s impressive run to be largely in the rearview mirror, there are still plenty of reasons to be cheerful in 2025.
Last year was undeniably one of US market dominance, with the S&P 500 climbing 25% versus 6% on the MSCI ACWI ex US. While some may lament their missed opportunities, it is crucial to remember it was backed up by consistent strength of the US economy.
Despite the headwinds of inflation and higher-for-longer interest rates, the US economy proved more resilient than many anticipated, driven by strong corporate earnings, a robust job market, and continued government spending.
It would be remiss not to mention AI, the buzzword that has investor’s tongues wagging, particularly in the semiconductor space. While the actual monetisation of AI products has been slower than expected or hoped, hyperscalers (large-scale data centres) continue to deploy increasing amounts of capex to ever more powerful Nvidia GPUs (a type of microprocessor that specializes in parallel computing).
How long this dynamic can persist remains an open question, but what’s undeniable is that much of the IP related to AI, whether that be the semiconductor designs or model architecture that underlies the technology, resides in the US, turbocharging returns.
Many fantastic companies appear to have been somewhat left behind in the recent market euphoria. The common theme being that these companies often possess qualities that have stood the test of time: predictable and recurring revenue sources providing greater stability and visibility into future earnings; healthy balance sheets better equipped to weather economic downturns and invest in future growth; and companies that consistently generate high returns on the capital creating sustainable long-term value for shareholders.
The reality is that while these types of investment opportunities are objectively attractive every year, they are relatively less attractive in economic backdrops like seen in 2024. Investors don’t want stable growth in an improving economy – they want companies geared to the upside.
One example is IDEXX Laboratories, a leading provider of veterinary diagnostics and software solutions. IDEXX has consistently delivered strong revenue and earnings growth, driven by a growing pet population and increasing demand for advanced diagnostic tools. IDEXX boasts a high proportion of recurring revenues, a strong balance sheet, and a history of delivering high returns on capital.
However, last year was challenging for the companion animal industry as vet visitation trends remained subdued on the back of COVID hangover effects and consumer pressures from lingering inflationary pressures. As a result, IDEXX’s fundamental performance was lacklustre (with revenues up 6% and EPS up 12%), and the stock has de-rated to the 2022 lows on pressures that likely to be transitory. The business is not broken by any stretch of the imagination but is somewhat out of favour with investors.
Adobe, the pioneer in creative software, is another example. Over the past decade, the company has transitioned to a pure subscription-based model, creating a highly predictable and recurring revenue stream with strong economics.
While the past few years have been noisy for the company, not least following the failed attempt to acquire emerging rival Figma in 2022, the key factor driving the narrative on the stock has been the perceived impact of AI on the business.
Just over a year ago, investors were overwhelmingly positive on Adobe, with new products expected to supercharge revenue growth. Today, we find that actual monetization has been slower than expected, a common theme across many software companies.
The effect has been a derating of the stock to ~20x earnings, or a sub-market multiple. While starting valuation should only be a single factor in an investment decision-making process, Adobe remains an excellent business, and the valuation seems increasingly conducive to a decent prospective return.
So, while it’s natural to feel a tinge of FOMO when markets are surging and portfolios aren’t keeping up, it’s important to maintain a long-term perspective. Investing is a marathon, not a sprint. The losers of last year can soon become the winners of tomorrow, and vice versa.
The US market is a lot more than just the Mag 7, which continue to increasingly dominate the headlines. There are lots of interesting companies that exist further down the market cap spectrum. Focusing on fundamentals, identifying undervalued opportunities, and maintaining a consistent investment strategy are key to achieving long-term investment success.