With lowered rate expectations driven by disinflationary surprises and the Federal Reserve’s dovish pivot, the S&P 500 Index nearly reached a record high in the last two months of 2023, led by Real Estate and Consumer Discretionary.1 Soft landing optimism and the sharp decline in long-term yields attracted investors to cyclical areas with depressed valuations such as small-cap stocks.
But we expect heightened equity volatility in 2024 as geopolitical and rate uncertainties and macroeconomic headwinds continue to test economic resilience. And, given the gap between market implied rate cuts and the Fed’s December dot plot, rate expectations may continue driving volatility in the first half of the new year.
Even so, secular industry trends that emerged over the past few years — increasing adoption of AI technology, CRISPR gene editing technology, and cybersecurity — remain intact and look likely to accelerate in the coming years, providing attractive long-term growth opportunities.
A decade after scientists first adapted the CRISPR gene editing technology to edit human DNA, the biotech industry welcomed the first FDA approved human therapeutic treatment, known as “exa-cel,” based on this revolutionary technology. Unlike the older generation of gene editing, CRISPR gene editing is precise, adaptable, efficient, and scalable. The FDA approval opens the door for the biotech industry to commercialize this technology breakthrough for medical use to treat a wide array of illnesses.
Therapeutic treatment is one of many applications of the CRISPR technology in the drug development value chain. It also can be used to diagnose infectious disease, facilitate drug discovery, and improve existing therapies. Neuroscientists have used CRISPR to discover why certain genes may protect brain cells from degeneration. Cancer drugmakers have used it to improve the efficacy of traditional chemotherapies and more advanced CAR-T cell therapies.
Large drugmakers and venture capital investors have seen its potential and invested millions to secure intellectual property. In 2021, venture capitalists invested $1.08 billion in 31 CRISPR startups, compared with $173 million in 2020.2 Most recently, Eli Lilly agreed to spend up to $600 million to acquire the rights to co-develop base editing programs for cardiovascular diseases from Beam Therapeutics.3
Despite biotech’s long-term potential driven by the CRISPR revolution, the industry has been out of favor over the past two years as rising interest rates weighed on small biotech valuations, wiping out billions of dollars of market value. Even given the strong rebound in the risk-on rally since November, prices of the SPDR S&P Biotech ETF (XBI) are more than 20% lower than they were two years ago and 50% below their peak in early 2021.4 Additionally, a solid price bottom seems to have formed around mid-$60 as XBI share prices rebounded and volume increased after its prices fell to around $65 (Figure 1).
Near-term rate expectations may continue driving the biotech industry performance given its -0.7 correlation with 10-year yields.5 But secular innovation trends may transcend monetary cycles, offering investors greater capital appreciation potential than the broad market over long-term investment horizons.
To capture a potential innovation boom in the biotech industry driven by the CRISPR technology, investors who can stomach near-term volatility may consider the SPDR S&P Biotech ETF (XBI) .
While earnings growth and profit margins of broad US equities may be challenged by weakening demand and higher financing costs, AI-related tailwinds may continue to provide growth opportunities for high margin technology leaders in 2024.
The current generative AI (GAI) technology cycle is driven by the world’s largest technology leaders who invest heavily in building the foundational large language models and who have plenty of customer data to train the models. It’s one of the reasons why the Magnificent Seven stocks6 attracted investors’ interest and outperformed the broad market in 2023 despite valuation pressures from high interest rates.
But to capture AI-related growth opportunities, investors need to take a broad view of the AI ecosystem and look beyond the traditionally defined Information Technology sector and the Magnificent Seven stocks. Early monetization of GAI technology is primarily happening in software development, online consumer platforms, social media, and AI infrastructure (e.g., advanced chip makers and cloud computing companies).
Companies in these segments are either AI enablers or have access to tremendous amount of data for training the large language models to improve efficiency in marketing and sales process and provide curated customer experiences. For example, Netflix uses GAI algorithms and users’ viewing patterns and feedback to identify successful genres, themes, and storylines. Booking.com launched its new AI Trip Planner powered by OpenAI’s large language model to create a new conversational experience for people planning a vacation. The Magnificent Seven and the Tech sector aren’t the only beneficiaries of the latest AI developments.
The SPDR® NYSE Technology ETF (XNTK), which equally weights 35 US-listed tech-related leaders across the Communication Services, Information Technology, and Consumer Discretionary sectors, may help investors position toward areas with positive fundamentals while broadening exposure to early beneficiaries of AI development.
Earnings estimates of XNTK’s benchmark have been upgraded by 10% since June, much higher than the S&P 500 Information Technology sector and the broad market ( Figure 2). Supported by strong earnings sentiment, it has outperformed the S&P 500 Tech sector and the S&P 500 Index by 6% and 9% respectively over the same period. Furthermore, despite having only 35 stocks, XNTK’s portfolio the Magnificent Seven accounts for just 20% of XNTK’s portfolio, compared to 47% of the Russell 1000 Growth Index and 39% of the Nasdaq 100 Index.7
Although XNTK’s significant gains in 2023 have lifted its forward price-to-earnings (P/E) ratio from bottom quartile at the beginning of 2023 to above its five-year median, its current valuations are well below its pandemic peaks and dot-com bubble levels.8 Additionally, its valuations are less stretched compared to the S&P 500 Tech sector, which is trading at higher forward P/E multiples than XNTK and within the top decile of its five-year history.9
To pursue AI-related tailwinds across major AI enablers and early adopters with less concentration in the Magnificent Seven stocks, consider SPDR® NYSE Technology ETF (XNTK).
As cyberattacks have become more pervasive and costly, governments and regulatory agencies have introduced new regulations to increase oversight and transparency of cybersecurity incidents. In December 2023, the SEC started implementing new rules requiring publicly listed companies to disclose material cybersecurity incidents and their cybersecurity risk management, strategy, and governance. With greater transparency, companies are incentivized to allocate more budget to cybersecurity risk management to protect their reputation.
The rapid emergence of generative AI may also increase demand for cyber defense and shore up cybersecurity providers’ capabilities to detect threats. Generative AI can help attackers to carry out very tailored, scaled, and harder-to-spot phishing and social engineering operations, creating an urgency to upgrading cybersecurity. Meanwhile, AI related technologies can also augment cybersecurity providers’ ability to detect threats and take actions at speed and scale. Higher demand and enhanced capability put the cybersecurity industry in a good position to benefit from AI technology development.
Increasing geopolitical tensions may keep the cybersecurity theme in investors’ focus. We anticipate 2024 to be fraught with geopolitical fracture points ranging from ongoing conflicts in the Middle East and the Russia-Ukraine war to critical presidential elections in Taiwan and the US.
Cyberattacks and disinformation have emerged as part of the offensive in the Russia-Ukraine war. Although the damage so far has been limited thanks to Western support to strengthen Ukraine’s cyber defense, it has become evident that hybrid warfare is the new reality. Furthermore, Russia’s interference in both the 2016 and 2020 US presidential elections showed how foreign adversaries may exploit cybersecurity weaknesses and abuse social media algorithms to distort electoral politics. Deepfake photos and videos created by generative AI have the potential to create even more challenging disinformation campaigns, requiring more advanced cyber-defense programs.
Against this backdrop, global enterprise spending on security and risk management is projected to increase 14% in 2024 compared to 2023 (Figure 3), outpacing overall IT spending.10 The US government is also expected to increase cybersecurity funding at a similar pace in 2024, allocating $13.5 billion for the Pentagon to advance its adoption of zero trust architecture and $12.7 billion for civilian cybersecurity-related activities.11
Given regulatory, technological, and geopolitical tailwinds, companies whose products and services are driving security innovation may offer strong growth potential.
To capture the broad range of innovative security firms, consider the SPDR S&P Kensho Future Security ETF (FITE).
To learn more about emerging sector investment opportunities, visit our sectors webpage.