Global equity markets rebounded strongly in 2023, despite continued high inflation, rising interest rates, and pockets of macroeconomic weakness in many parts of the world. While the water sector was not immune to the crosscurrents of the global economy, the sector posted solid returns for the year. Narrow leadership in U.S. equity markets, driven largely by technology companies, resulted in the water sector underperforming broader equity indexes for the year. Over a longer period, performance in the water sector, as represented by the S&P Global Water Index, remains compelling, outpacing global equities.
Investment into the water sector continued to accelerate in 2023, driven by continued water scarcity, quality concerns, and infrastructure issues that are exacerbating global water challenges. Funding from both private and public sources remains strong, as governments and businesses continue to focus on mitigating water risks. With strong investment tailwinds, earnings in the water sector remained resilient during the year and are expected to continue to grow well into the future as global water challenges intensify. We believe the sector continues to be well positioned to compound at an attractive growth rate over many years and deliver compelling risk-adjusted equity returns.
We continue to have a constructive outlook for the water sector in 2024, and our conviction remains high that secular tailwinds will support the sector over the long term. While the current macroeconomic outlook remains murky, we believe water infrastructure and equipment and technology companies are well positioned for growth in 2024.
Within water infrastructure, water utilities continue to exhibit strong fundamentals, led by the need to repair deficient infrastructure and improve resiliency. Additionally, capital investment is expected to increase in the coming years as regulations around emerging contaminants are put forward in many parts of the world. In developed markets, we expect U.S.-regulated utilities to continue to grow earnings in the mid-to-high single digits and a step-change upward in U.K. water utility investments over the coming years. Emerging markets are focused on building out needed infrastructure to expand connectivity, improve water quality, and reduce pollution. We believe the combination of favorable earnings trajectories and resilient cash flows supported by regulated business models places utilities in an advantageous position in the uncertain macroeconomic environment.
The water equipment and technology subsector is also expected to grow earnings next year; however, fundamentals are mixed across various end-markets. We expect the municipal end-market to continue its strong growth trajectory as utility and state and local budgets remain healthy and government support (i.e., the Infrastructure Investment and Jobs Act) starts to trickle into the market in certain geographies. We see the adoption of technology, including advanced metering infrastructure, leak detection, and testing applications as a key driver of municipal market growth. Pending PFAS regulation is also expected to drive upside for companies offering technologies that detect, treat, and remove the forever chemicals from drinking water sources.
The industrial end-market remains largely constructive, although it is bifurcated between subsectors and geographies. Water companies that develop and deploy technologies to the microelectronics, energy transition, and life sciences markets and benefit from reshoring initiatives are expected to show solid growth in 2024, barring a deep recession.
Non-residential and residential end-market fundamentals appear challenged heading into 2024. Non-residential construction activity cooled in the second half of 2023 and appears set to soften overall next year. While there are bright spots in activity (e.g., data centers and institutional), we do see a more challenging environment for other submarkets such as warehouse and multifamily development. Overall, we expect companies levered to growing areas of the market and with more exposure to repair and replacement activity versus new construction to exhibit stronger earnings growth. Residential activity bounced along the bottom for most of 2023 as affordability issues largely paralyzed the market. We expect the trend of new development taking market share to continue into the first half of 2024. With the support of lower interest rates, we see modest growth in residential activity benefiting companies that sell water equipment and technology into the end-market.
Lastly, the agriculture end-market had a tough year in 2023, as lower commodity prices pressured farm income and weighed on investment in water equipment and technology. We anticipate another challenging year in 2024 for OEMs in the end-market. We continue to have a positive view on demand for irrigation equipment over the long term, as secular drivers including food security, more efficient water use, and crop yield enhancement are expected to drive solid growth.
Entering 2024, equity markets continue to face several uncertainties related to the eventual “landing” of the economy. We believe we have positioned the portfolio in companies with high-quality assets and management teams that will execute through any macro outcome and continue benefiting from secular tailwinds in the water market. We remain focused on “pure-play” water companies that provide leading solutions in improving water supply, quality, and efficiency and are positioned to outperform through a full economic cycle. As this occurs, we believe water investments will be rewarded over the long term.
This material is for informational purposes only and not intended as investment advice or a recommendation to buy or sell any security. Information and opinions expressed are those of the authors and may not reflect the opinions of other investment teams within Duff & Phelps Investment Management Co. Information has been taken from sources we believe to be reliable, but its accuracy, completeness or interpretation cannot be guaranteed. Information is current as of the date appearing in this material only and subject to change without notice. Statements concerning financial market trends are based on current market conditions, which will fluctuate. This material may include estimates, outlooks, projections, and other forward-looking statements. Due to a variety of factors, actual events may differ significantly from those presented. Investing involves risks, including the possible loss of principal. Duff & Phelps Investment Management Co. services are not available in all jurisdictions and this material does not constitute a solicitation or offer to any person or entity in any jurisdiction or country where such distribution or use would be contrary to law or regulation.