Global Perspectives: Where will the next wave of growth leadership emerge?

Lara Castleton: Hello and thank you for joining this episode of Global Perspectives, a Janus Henderson podcast created to share insights from our investment professionals and the implications that they have for investors. I’m your host for the day, Lara Castleton.

The S&P 500 has dominated markets for over a decade, but so much of that return has been driven by a handful of stocks with concentration risk front and center. Today, many investors are asking where the next wave of growth leadership will come from. Which stocks will be the next winners? Which sectors will they be in? What will we name them? Identifying this next generation of market leaders is undoubtedly challenging.

But relying solely on passive exposures risks missing much of their growth potential. To discuss how we’re thinking about the future leaders and transformational growth at Janus Henderson, I’m thrilled to be here with Brian Recht, Research Analyst and Portfolio Manager. Brian, welcome back to the show.

Brian Recht: Thanks, Laura. It’s great to be here. Thank you for having me.

Castleton: Let’s just get into it. Growth has been winning for so long. Why is it still winning today?

Recht: Yeah. So, when we when we think about end investing, we typically start with where is growth in the broader economy coming from. And over the past 10 to 20 years, a lot of the growth came from the public sector, from federal spending. And we think that’s slowing down going forward. Obviously, we’ve seen the headlines about DOGE and the focus on reining in public spending. So, for us, we think there’s really five themes driving growth in the economy from here. Those are obviously AI, we think the move to the cloud, we think digitization – both in terms of retail digitization, e-commerce, financial digitization in terms of payments – healthcare innovation, and finally broader deglobalization. And we think all these themes are broadly in their infancy. Right now, tech spending as a percent of total GDP is approximately 5%. We think that can double over the broader course of time. Close to, you know, 75% to 80% of total workloads are still on premises. Those are going to continue to migrate online into the cloud.

If we look at healthcare innovation and the pace of drug discovery and innovation there, it is only accelerating. Deglobalization: We see continued announcements on domestic CapEx [capital expenditure] spend both from obviously the AI, the semiconductor companies, as well as from many healthcare companies spending domestically. So, for us, we look at where is growth in the economy coming from.

Castleton: Grow themes looking for, but again, how we got here today was these Magnificent 7 companies. How did they get to where they are today? Was it predicted 10 years ago that it would be these seven companies?

Recht: Obviously of the Mag 7, there’s a lot of disparate business models, and there’s been a lot of evolution in the companies throughout the past decade, or 15 years. So, I think it would have been very hard to predict 10 years ago where those companies are today. Where we spend a lot of time is trying to identify the next Mag 7. Who are these fantastic companies with huge opportunities, with best-in-class management teams tackling really big problems that, when we’re chatting a decade from now, have the opportunity to be in the next MAG 7 of leading companies?

Castleton: Yeah. So why is it so important? You kind of alluded to it … and, very hard to predict that the seven would be what they are today. Obviously, those names have changed, but why is it so important to then look outside of those names going forward?

Recht: Over the past 10-15 year, we’ve seen this rise of the Mag 7, and continued outperformance. And first of all, the Mag 7, they’re phenomenal companies with fantastic competitive advantages, fantastic economies of scale, and they’ve deserved their valuations and their performance. Going forward, we think there’s reasons why we could see a broadening of the stock market and the economy from here.

So, a few things jump to mind. First, over any past 10-year period, the largest companies have tended to underperform going forward. So, if I look in, you know, 1980, 1990, 2000, the largest five to 10 companies at that time have not been the largest five companies going forward. And a big part of that is everything from an innovator’s dilemma to, you know, it’s just economies of scale and it’s hard to continue growing.

Most recently, we’ve seen the largest companies continue to dominate at the broadest level. We think stock prices follow earnings growth, and the largest companies have grown faster than the rest of the market. In ‘23 and ’24, I think the largest companies in the Mag 7 compounded earnings at a mid- to high-30s rate over that two-year period, where the rest of the market grew at a low-single-digit rate. So, if you look at the stock price performance, it’s really followed the earnings growth.

But the question is, what happens going forward? And we think going forward, the earnings growth of the largest companies is set to slow a little bit relative to the broader market. So, we see the largest companies’ earnings growth slowing, while the S&P 493 – you know, everything ex the largest companies – are going to see inflecting earnings growth. So, we think this earnings cadence is going to converge on each other.

And at the same time, if we look at valuation, the largest companies are trading at a pretty significant premium to the rest of the market. So, we look at that by looking at the market-cap weighted S&P 500 versus an equal-weighted S&P 500. And we see about a 5- to 6-turn premium for the market-cap weighted S&P, which in our mind is a proxy for the largest names in the index. So going forward, you have the largest names at all-time high concentration levels, all-time high absolute market cap levels, with potentially slowing earnings growth. At the same time, they’re trading at a significant premium to the rest of the market.

So, for us it’s a really exciting time to be building an idiosyncratic portfolio with names and ideas that may be outside the largest names in the market.

Castleton: So, we just recorded a podcast with Denny Fish, who you know very well, and heads up our Global Technology team, so very invested in AI. And we talked deep into AI. Is it not true that the Magnificent 7 companies, though, have the most amount of scale and the most amount of spend in AI, and so therefore are going to continue to be the next winners? Or are you seeing other areas where, you know, outside of those names, AI is going to be able to be implemented?

Recht: Clearly, the largest 7 names have significant scale and balance sheets. I think I saw a stat that this past quarter, the largest seven companies spent on CapEx twice what the rest of the economy spent in general. So clearly there’s significant scale. But what we see is, is this scale is going to permeate to the rest of the economy and to a lot of other companies.

So, one thing we believe is, is there’s going to be a number of large language models. So, you’re gonna have a number of really good large language models, and the cost of inference against these models is going to come down significantly. So, what this means is, if you’re a company with a non-multi-trillion-dollar market cap, you’re going to be able to leverage this lower cost of inference, potentially – right, API – into one of these leading models, and you’re going to be able to do this in a less capital-intensive way.

So, we’re starting to see benefits across companies, both in technology and non-technology companies. We met with one of the management teams, and they said, you know, we’re not explicitly a technology company, but if any company isn’t using AI to their benefit, they’re not going to be a winner over the next decade. And we truly believe that. So, we’re seeing AI proliferate across the economy, from companies in healthcare with drug discovery, from, you know, travel-type companies with chatbots that can help you book a trip end to end based on your own unique preferences.

And, broadly, a number of companies talking about how this is going to fundamentally change their cost structure. Perhaps you can continue to grow revenue with headcount that is flat or even down due to increasing speed of engineering, and coding with assistance from AI and LLM. So, we are really excited to see the benefits of AI, not just from the largest companies or the, you know, the most obvious beneficiaries in the semiconductor sector, but really for a broad swath of companies, I think.

Castleton: Something you mentioned there is really important for investors: It’s probably quite easy for these companies to throw out AI and garner some attraction, but it is very clearly difficult to see how AI is actually going to implement the business. You have direct access to the companies that you manage, to their management teams, and you meet with them frequently. That is something you don’t get by just passively investing in this. You get to distinguish which companies are saying it, which ones mean it and are actually going to use it to their benefit.

Recht: That’s what’s fun about this job: these conversations with these really smart, really interesting leading-edge management teams. And I guess a few data points on where we’ve seen the benefits. So, starting with, you know, the largest companies, this kind of secular theme of transition to the cloud. I think you know, seven years ago, in the beginning of 2018, the total run rate cloud spend of the largest three companies was about $29 billion a year. This past quarter, that run rate spend was about $265 billion. So that’s a significant increase in seven years. And the growth rate is actually accelerating over the past four quarters to what we saw most recently. And when you combine that with the fact that the vast majority of workloads are still on premises and have to move to the cloud, and when you build in AI workloads, that’s certainly a benefit.

We’ve already seen of acceleration in AI. We also see it across the cost structures of a number of our companies. How we measure this is, we look at headcount of all our companies as they talk about it every quarter and every year. And we’re seeing flatter head count growth against what is still very robust revenue. And perhaps more important is not just the absolute headcount growth being fat, but when we talk to these management teams, they’re saying not only is head count growth flat, but the amount of innovation and product updates [they’re] able to roll out is really accelerating against that, which is exciting to see.

Castleton: So, speaking of talking with management teams, what are you hearing out of the recent earnings season? And, in particular, I think we have to address the comment on tariffs. What are you hearing from teams in terms of managing the tariffs, that volatility?

Recht: So, I think one piece of feedback we’ve gotten from the management teams is that this quarter was quite the roller coaster. It may seem like distant history, but the second quarter started in the beginning of April with Liberation Day and everything that came with that. So, I think companies started in a little bit of crisis mode and a lot of uncertainty with what was going to happen. And as you progress through the quarter, there got to be more and more certainty as trade deals were announced and, largely, as projected, significant inflation did not come through the economy and did not come through these companies’ balance sheet. So, what they saw was stabilization. In many cases they saw accelerating revenue growth as we worked through the quarter. So, while there’s still a bit of uncertainty, the conversations have been fairly sanguine.

We don’t want to be overly Pollyanna. So, we’re obviously … we always stay very close and somewhat paranoid in terms of what are they seeing, what is the economy looking like? But so far, the message we’re getting is one of a fairly constructive nature.

Castleton: So then what will you be looking for over the next six months with your companies?

Recht: We do pay close attention to the broader macro data and signals we’re seeing, and what we’re seeing right now is still a fairly healthy jobs market. I think unemployment is 4.2%, which is below historical averages. Wage growth stores [are] in a fairly good position, and inflation, while it’s still elevated above the long-term 2% target, it seems to be potentially headed in the correct direction, and there’s suggestions that we could have rate cuts going forward. So, all these strike us as fairly positive.

From a company-specific factor, we’ve obviously seen a lot of investment in the economy, so we want to see the revenue come through against that. So, we’re spending a lot of time thinking about the ROIC, or the return on invested capital, of the largest companies. And then for kind of the broader swath of companies, we want to see the revenue use cases. If a company’s talked about building a booking agent for travel, are we seeing adoption of that? How is it working? We’re constantly testing all the applications ourselves. We also want to see the innovation and continuing acceleration in innovation and engineering progress, which was the companies have talked about. So, these are all things we are measuring very closely as we monitor companies and the broader economy going forward as well.

Castleton: Lots to think about near term, but definitely long term, especially as we talk through what are going to be those next transformational growth companies to take the market for the next decade. Your team is very ingrained in doing the fundamental work, speaking with the companies. Appreciate your insights here today, Brian.

We hope you enjoyed the conversation. For more insights from Janus Henderson, you can download other episodes of Global Perspectives wherever you get your podcasts or check out our website at janushenderson.com. I’m Lara Castleton. Thank you. See you next time.