MARKET COMMENTARY

Emerging Themes in a Post-Pandemic World

07.14.2020 - Carin L. Pai, CFA

Key Takeaways

  • Shifting production out of China may favor firms focused on smart manufacturing and logistics aiding in the regionalization of supply chains.
  • In healthcare, we expect companies focused on tools and diagnostics and health technology to benefit over the longer term.
  • Technological innovations will likely favor data science companies, digital content providers, public cloud adoption and collaboration tools.
  • Our team believes e-commerce, along with contactless payment and the shift to online advertising, will accelerate.
  • A greater emphasis by investors on personal values may lead to more interest in ESG investing.

There is no doubt that life after COVID-19 will be different. With this in mind, we are focusing on several investment trends that we believe will persist in a post-virus world.  

Deglobalization: The Shift In Global Supply Chains Away From China

One of the major lessons that multi-national companies have learned from COVID-19 has been their overreliance on China for manufacturing which heightened the need for more local sourcing and production.  This issue was initially exposed during last year’s trade tensions between the US and China. At the same time, production costs in China have been rising over the past decade. These conditions have reduced many companies’ incentive to outsource their manufacturing, especially of consumer goods.  

Therefore, many firms (particularly US-owned) are bringing portions of their production process back to the US or to other locations with friendlier dispositions. Up until now, about one-third of US companies have had production facilities in China. This proportion is similar across consumer, discretionary, healthcare, industrial and IT sectors. More than 40% of these companies have already moved or are in the process of relocating production out of China, with one-third in the planning stage.[1] The top destination is the US, with Canada a distant second, as companies seek to align their production closer to their customers.[2]

This shift could represent a largely negative scenario for China, as the loss in production would likely lead to job losses and slower economic growth. From a US perspective, this could have a positive effect on jobs and company earnings, particularly for industrial companies which are focused on smart manufacturing and logistics to aid in the regionalization of supply chains.  

We also find the impact of automation and electrification, i.e., innovation in battery powered vehicles and shifting economic sectors to electricity-powered technologies, to be intriguing. The latter may see more applicability in emerging markets where urbanization and energy consumption levels have been rising.  

Healthcare Remains a Key Driver

We expect to see continued growth in the healthcare sector, especially in biotechnology, as the aging global population will continue to drive health care demand.

COVID-19 has highlighted the lack of investment in the healthcare system, combined with aging demographics.  This shortfall will likely lead to more spending on research and development, along with the need for increased local manufacturing, especially for drug compounds, medical supplies and equipment. We expect companies focused on tools and diagnostics and health technology to benefit longer term.

In addition, we may be beginning to reap the benefits of scientific and medical advancements made over the past decade. These efforts have led to a surge in novel drugs and treatments. Advances in genomics and proteomics, as well as in DNA sequencing technologies, have enabled a more informed and targeted approach to designing drugs. 

Scientists and researchers are also better equipped to identify new mutations that drive diseases, to design new drugs with better efficacy and fewer side effects, and to improve diagnoses of patients so that the best treatment options can be found.

One lesson learned from the pandemic seems to be the desire to improve overall health outcomes.  As a result, investment in public health infrastructure, which provides communities with the ability to prevent disease, promote health, and deal with both acute threats and chronic challenges, may become a bigger priority.  We believe that opportunities such as healthcare management and services are attractive over a long-term horizon. 

Everything Is Digital

Working from home due to the pandemic has inspired several technological innovations.  And, the reduction in transportation costs, commuting times and easy access suggest that companies will retain video conferencing, even after the pandemic has subsided. Clearly, the market has agreed, based on the performance differential between the large technology stocks which enable connectivity, and the broader market on a year-to-date basis.  


Five largest stocks in S&P 500 have returned +25% vs. -9% for remaining 495 stocks (year to date)
Year-to-Date Growth of $1

Source: FactSet. As of July 2020. Five largest stocks include Microsoft (MSFT), Apple (AAPL), GOOGL (Google), Facebook (FB) and Amazon (AMZN). Past performance does not guarantee future results and results may differ over future time periods.


Over the long term, working remotely helps lower costs by reducing corporate real estate footprints.  Companies are likely to shrink their physical office spaces which may lead to a negative impact on commercial real estate as many firms relocate out of cities, offer a virtual work environment to more employees and reduce their leasing requirements.  

Sheltering at home and social distancing have also accelerated and cemented trends in digital entertainment, virtual learning and network connectivity.  In many ways, consumer and corporate behavior will undoubtedly see permanent changes.  We view these changes as benefiting data science companies, digital content providers, public cloud adoption and collaboration tools that allow working together while working apart.

In addition, 5G mobile technology may accelerate the introduction of artificial intelligence across industries, leading to advances in driverless cars, smart cities and telemedicine. One estimate suggests that 5G use could drive incremental value across those three categories by $7 billion, $20 billion and $32 billion, respectively, by 2030.[3]  Our team is investing in semiconductor companies well positioned to take advantage of this trend.

The Shifting Retail Landscape

Retail stores are adopting cash-free interactions and incentivizing customers to use their apps for ordering.  This includes small shops who are moving their sales online to compensate for decreased in-person sales and to reach non-local customers. These shifts have no doubt contributed to the ongoing decline in brick and mortar stores while accelerating payment processing companies.

Some of the changes occurring today within the retail sector may not lead to new winners. Instead, retailers who were early adopters of online ordering as well as loyalty programs that offer promotions and discounts for frequent purchases have been able to continue to meet customer needs well in this environment.  We believe that safety, health and convenience will remain critical for consumers.

Delivery service is on the rise and will remain a competitive advantage for retailers and food service. Many of these firms struggled before the pandemic, but these businesses have improved quickly during the shutdown with consumers using on-demand delivery at extreme levels, including food. Companies possessing strong logistics to handle front-to-end sales transactions will likely thrive.  We believe e-commerce and, therefore, contactless payment and the shift to online advertising, will accelerate.

More than just Amazon and Alibaba

The e-commerce ecosystem has significant breadth and depth

Source: Franklin Templeton.

An Awareness of Deficiencies In Society – The S-Factor

Clearly, the US is engaged in a national discussion on social justice issues. Policing and community involvement are two leading themes in how communities will interact with each other in the future. With such a bright light shining on social and economic justice, we think that the crisis may lead to a greater emphasis on investing based on personal values.

This trend could create a greater awareness of environmental, social and governance (ESG) investing, with an emphasis on the “Social.”  The corporate response to the pandemic, such as private companies manufacturing medical supplies, could highlight the role that firms play in addressing social problems.  At the very least, investors may view the crisis—and how companies respond—as an opportunity to ask questions about the social issues that matter to them. 

After the Great Financial Crisis, strong corporate governance characteristics brought outsize valuation premiums to companies.  We believe that today’s crisis will drive social attributes (for example, employee satisfaction, leave policies, product safety and labor relations) to the forefront and will support a premium valuation for strong social factors. 

Diversity have been gaining traction as financial considerations for investors. In fact, some research has shown that increased diversity and a more inclusive workforce can be indicative of strong company performance.  For example, one analysis found higher return on equity, lower accruals and lower ROE volatility for companies with high gender diversity relative to sector peers.[4]  Also, management consulting firm McKinsey & Company found that firms in the top quartile for racial and ethnic diversity are 35% more likely to have financial returns above their respective national industry medians.[5] The implication of these results is that greater diversity may improve the overall functioning of an organization.

Implementing Change In Portfolios

Investors seem to be increasingly searching for companies that align with their values.  But that raises some challenging questions: How can we identify those companies? Which companies are forward-looking enough? Which have the management teams capable of implementing change?  These are some of the questions we factor into our decisions, along with traditional financial metrics. Additionally, our team has seen more companies displaying a growing awareness of ESG factors. 

As more investors have become interested in ESG, more investments have entered this space. Sustainable investments in the US are attracting new assets at a record pace, totaling over $20 billion in 2019. That's nearly four times the previous annual record in 2018.[6]

We believe this trend will continue, both in terms of individual companies’ contributions to being more sustainable and responsible, as well as increasingly more viable and defined strategies for impact investing. In the search for some silver linings from COVID-19, we hope we have highlighted a few here.

 

 

 

[1] UBS, US Senior Executive Survey, 6/23/2020.

[2] UBS, US Senior Executive Survey.

[3] Morgan Stanley, “For Investors, Could 5G Stream Higher Share Prices?”, 2/25/2019.

[4] Morgan Stanley Research, “Putting Gender Diversity to Work: Better Fundamentals, Less Volatility”, May 2016.

[5] McKinsey & Company., “Diversity Matters”, January 2015.

[6] Source: Morningstar Direct, 12/31/2019.




The information provided is intended solely to provide general information. The information and opinions stated may change without notice. The information and opinions do not represent a complete analysis of every material fact regarding any market, industry, sector or security. Statements of fact have been obtained from sources deemed reliable, but no representation is made as to their completeness or accuracy. The opinions expressed are not intended as individual investment, tax or estate planning advice or as a recommendation of any particular security, strategy, or investment product. Please consult your personal advisor to determine whether this information may be appropriate for you. This information is provided solely for insight into our general management philosophy and process. Historical performance does not guarantee future results and results may differ over future time periods.

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