Tune in to our latest “Talking Markets” podcast and hear the conversation. A transcript follows.
Alistair MacDonald: Hello, everyone. And thank you very much, indeed, for joining us.
So, gentlemen, after remarkably strong rallies across various markets, what are the key risks and where do you still see opportunities? Grant?
Grant Bowers: When we take a look at the US equity market, I think we’re not alone in being quite amazed by the resilience that the market has shown following the very violent selloff in February and March. And then, really just seeing the market rise and rally on really hopes and dreams of better days ahead. And I think we’re getting closer. I think there’s definitely light at the end of the tunnel now. So, as we look at the market, we really see a market that has gone through a V-shaped recovery. It has had very tremendous strength, but we’re starting to see signs of some moderation, that the snapback recovery is starting to slow down a little bit. And, I think you’re going to start to see some volatility in the market, as there are a lot of questions around how sustainable this recovery is, whether or not the broader pieces of the US economy will continue to sort of move forward on the pace of recovery. That said, we view this as much more of a pause than an overall pullback. We think that as we look out further into 2021 on the back of a vaccine-driven sort of unlock of pent-up demand, that we will see a reacceleration of not only GDP [gross domestic product] growth, but consumer spending. It will be probably broad-based in many ways. We see unemployment has been improving. Corporate earnings are recovering, and GDP growth will accelerate on the back of that.
One of our big themes, digital innovation, continues to lead, transforming what I would call the more traditional or, sort of, classic economy. It’s really moving beyond technology and to many other sectors of the market. And some of our biggest opportunities that we find right now are really this idea of how digital innovation is moving beyond technology and into industrials, health care, financials, and really bringing those industries up to speed and bringing them into a more competitive positioning for the global landscape.
One of the risks that we highlight—I couldn’t sit here and talk about US equities with bringing valuations into the mix. Our belief is that we are moving closer to what I would call fair value. A lot of the future returns of this market are going to be driven by earnings growth. And the pace of earnings will be a real sort of predictor of returns, as well as a driver of growth for the overall economy.
We are continuing to monitor the vaccine rollout, as well as some of the new variants, as some of that could bring about a potential for stall risk of the overall economy. And all of this really ties together into sort of a bigger picture of how is this accelerating GDP growth going to affect inflation? How is it going to affect interest rates? We have a tremendous amount of stimulus in the system, really driving a lot of this recovery and supporting consumers. And it’s something that we’re watching very closely over the next year and probably well into 2022.
Alistair MacDonald: Thanks, Grant, and over to you Chetan.
Chetan Sehgal: We think about our opportunities and risks in a very simple framework. We look at structural opportunities. So, this is usually called the beta of the asset class. So, what are the structural opportunities within emerging markets? We talk about penetration. You talk about demographics. You also now talk about internet, e-commerce, the growth of the electric vehicles, the growth in renewable energy. So, how solar prices have actually become quite cheap, as compared to coal, and challenging for lower energy costs.
So, there are a lot of structural opportunities in emerging markets. There are billions of consumers and economies in different states, but generally, everybody’s trying to upgrade. There’s a lot of technological innovation. And luckily for emerging markets, at this point in time, technology really favors emerging markets. The other issue really is about sustainability and, you know, people talk about the sustainability of the rally of the market, but for us, what is really important is: do these companies have sustainable business models? Because, for example, if you say that we are bullish on electric vehicles, you know, today you have one kind of batteries which are there, but tomorrow you might have solid-state batteries, and that will be a challenge. So, we have to evaluate from a point of view of sustainability as well, not just in terms of the market price and valuations, but also whether the business models by themselves are quite sustainable. So that is our focus area.
And, most important, really, is stewardship. And when we talk about stewardship, we call it the delta, and the delta really is about the policymaking which takes place. So, it’s not just stewardship at the company level and the governance, but also the fact that there is a lot of policymaking which individual governments are doing. And therefore, that is another challenge which one needs to look at. How does stewardship and control of the governments or the economies and companies actually play out? So, our framework is very simple: structural, sustainable and stewardship. And I think we use that to evaluate both opportunities and the risks.
Alistair MacDonald: Great. Thanks. Chetan and Grant, digital innovation was mentioned by both of you and so, specific to equity markets, where would be your focus? Which particular themes or areas are you finding the opportunities where there’s still value present? Chetan, would you like to start?
Chetan Sehgal: You know, when we look at digital, it started off with the internet and e-commerce, then software companies catering to the enterprise. So, a lot of the enterprises also digitalizing yourself. The consumers are also buying digital, you know, laptops and phones, etc. So, now digital is actually quite pervasive. And what we are looking at is how companies are using this. There was an initial phase in which you just buy-the-internet companies and then you have e-commerce companies, search companies, but I think it’s becoming very pervasive. And we think that it is a key to success. It is a basic necessity to do digitalization of their business. And, if you’re not digitalizing, you’ll probably be out of business. So, so to that extent, I think all opportunities which we are looking at are really about digitalizing companies.
Alistair MacDonald: And Grant?
Grant Bowers: Yeah. Chetan said that in a very well-stated view. You know, we’re based in Silicon Valley, really at the heart of a lot of this digital innovation. And so, we’ve had a real, sort of, front-row seat of understanding the evolution of technology and this digital transformation as really what started out in technology and still really exists in software and hardware is now starting to expand beyond tech. It’s creating what we think is really an amazing time for not just technology and so-called digital innovation, but also just disruption and change beyond tech. And so, a lot of the areas that we’re focusing on, really for 2021 and beyond, are the areas where we think disruption and digital transformation will impact industries beyond, sort of, traditional technology.
So, areas such as financials, I think we’re all very familiar with how technology and the digitization of portfolios and client data, as well as assets, has changed the way we think and manage portfolios and the asset-management industry. But really, what we’re going to see in the future is a disruption of the traditional banking model. A breaking down of a lot of those competitive moats that they hold. And then, we’re also going to see it spread out into the way we interact and use money and how we buy things, how we spend things. I think China is probably the premier example of a country embracing e-commerce and digital currency to really bring that sort of digital spending to the forefront at a very rapid fashion.
Beyond areas of financials, we think industrials are really ripe for change. Many old-line industries are investing heavily in data analytics and robotics. I think we can always talk about what’s going to take place with alternative energy or electric vehicles.
Beyond industrials, I think health care is going to be a really interesting place to invest in the future. So, what we’re seeing in health care is really a renaissance. We’ve seen that really front and center with the vaccine development with the RNA-based vaccines. But ultimately, what it is, is the combination of genomic advancements and lowering the cost of genomic sequencing, combining that with data analytics and computing power to drive a new era of personalized medicine, of precision medicine that ultimately is going to deliver better cures, better treatments, better outcomes for patients.
We think that we’re really in the early, early days of this digital transformation theme in areas like financials and industrials and health care, and that thinking about it really beyond tech is going to be really what we’re going to be talking about and investing in probably for the next three to five years as we look out into the future.
Alistair MacDonald: Okay. Excellent. Very exciting story there from both of you. So, very good to hear.
Growth equities have outperformed value by a huge margin in recent years. Do you expect this to continue in 2021? Grant, would you like to start?
Grant Bowers: You know, I think that’s a question that’s on everybody’s mind. I have to admit I’m probably a bit biased being a growth investor. But, when we think about some of the structural changes that we’ve seen take place over the last decade in the market, really post the financial crisis, I think we can rationally sort of start to put a framework around why growth has continued to outperform value.
One of those being, really, some of what we’ve talked about already around disruption. Traditional, value equities, our view is that they’ve existed and had their valuation anchored around this idea of a competitive moat that is sort of eternal, that cannot be broken down. The companies may, or may not, grow at rapid rates. They’re very dependent or very cyclical and dependent on GDP growth to really move that. But ultimately, these are businesses that will endure and be around for a very long time and have been very good investments historically. When you can buy them at the right price, you know you’ve owned a great asset forever.
I would put out, and please understand that my framework is as a growth manager, that what we’ve seen with digital transformation and a lot of the disruption, the ability of companies to move faster and quicker into industries and disrupt old line industries has broken down some of that competitive moat that a lot of traditional value, not just companies, but really industries enjoyed for decades. And I think that genie is out of the bottle. I think that sort of disruption and breaking down of their competitive moat is something that’s probably going to endure for a very long time.
So, I think of value versus growth, not necessarily as cheap versus expensive, but much more of on the line of competitive positioning and competitive moat and how enduring and sustainable that growth can be. Because even for us on the growth side, we’re looking to buy long-term, high-quality, sustainable growth franchises, which share a lot of characteristics with traditional value. We just are willing often to look a little further into the future and maybe pay a slightly higher valuation for that.
So, my belief is this growth out-performance will continue. It will be volatile at times, and it’s not going to outperform every day or every month or every quarter, but I think the era of growth, outperformance is probably here for much longer than many people feel.
Alistair MacDonald: Thank you, Grant. Chetan, do you have a different perspective?
Chetan Sehgal: You know, when you say growth versus value, I usually refuse to take that question. Because for us, the most important thing is what is the sustainable earning power of a company? So, you can have very fast-growing companies, which still don’t have sustainable earning power. And you’ve seen the example, there were companies which were making DVDs, you know, and where do you see them now? Because at one point in time, people were buying DVDs, etc., and suddenly went out of business. We do not look at it from a lens of growth versus value. We look at it from the point of view of whether a company has a sustainable advantage or not.
In emerging markets, there’s another issue, which hurts traditional value from actually outperforming. And, that is the restriction on M&A [merger and acquisition] and corporate restructuring. Still, many of the companies are owned by families and by people, and there’s a reluctance of corporate restructuring to take place. So, in the US or in the West, you see a lot of companies coming in, takeovers taking place and restructuring happening, but you don’t see that in emerging markets. So that is one negative for the so-called value companies. But what is also happening now is that with digitalization, the overall economic growth in many of the countries is actually improving. And there is deflation as well. So, the consumer is actually having more purchasing power as a result of digital change, and that is giving an impetus to the traditional manufacturers as well. So, a lot of the traditional manufacturers are getting an impetus because digitalization has opened up new markets, has allowed them to source materials cheaper, and that actually results in better growth.
One more point, if I may, you know, a lot of the new talent does not go and join some of these old business houses. So, so if you ask a young guy, where is he going to join, and which are the companies you’d like to work in? Okay, these are not going to be the old traditional companies. And this is a big challenge which old traditional companies are facing, that they are not actually getting the talent which they require to start growing their business again. So, that is something which is against the so-called value companies as well. But we’ve seen that companies which change their business model, are putting in the right leaders, getting into new technology areas, even if they are from the value background, they tend to do reasonably okay. So, I would say it’s not a growth versus value debate. It’s the question of really sustainability.
Alistair MacDonald: Okay. Thank you. Definitely a different perspective. So back in 2019, The Economist and the Johns Hopkins University worked together on a risk ranking index in which they ranked countries by their preparedness for a pandemic.
Now, the United States and the United Kingdom were ranked number one and number two. Unfortunately, for my compatriots in England, this alas, wasn’t how things panned out. More generally, if we look at what occurred last year, both in terms of health outcomes and economic resilience, I think there was enormous amount of surprise and expectations were confounded by the fact that many emerging markets, particularly in North Asia, performed very strongly.
And so, Chetan, the question then with that, is given the outperformance of a number of North Asian countries relative to the West, how does this affect the long-term outlook between emerging markets and developed markets?
Chetan Sehgal: It’s a very interesting question, and I think not about governments being prepared, it’s about how the societies are prepared. You know, how are the people living in those countries prepared to deal with it? So, when you do a survey and you say that the government is prepared, which I think in many cases, the Western world was actually not that prepared, but the societies in emerging markets, and especially, you know, in North Asia and emerging markets, they have seen previous crises as well. They’ve seen SARS come in and they’ve seen other virus attacks as well. And I think the societies were very well-prepared and mentally, they are tuned to the fact that they need to go behind the mask. They need to follow social distancing. I think that organization has really helped, you know, these countries to come out of it, or have a better response, as compared to the outcomes which we’ve seen in the Western world.
You know, that doesn’t actually curtail the creativity and innovation of those people. So, you know, people say, “listen, I’m in a democratic society. I’m free to do what I want.” And, if people are actually being over-regulated, they will not actually have the creativity and the flare, but that is not the case. You’ve seen that a lot of creative solutions are coming out of developed North Asia. So, I think it’s just about how the society is organized, how people are living there, and I think that gives them a big advantage for the future.
Alistair MacDonald: Are we facing the roaring twenties again, similar to the last century? And if so, when does the party stop and why? Over to you, Grant.
Grant Bowers: The roaring twenties analogy is a tough one because I think there are a lot of similarities. There’s a lot of tremendous amount of pent-up demand on a consumer level, on the corporate level. I think we are going to see, you know, 2021, ‘22, and probably even into ‘23, in this above-average GDP growth-type of environment, just really driven purely by stimulus and a reacceleration of the economy. So, we probably will get a lot of the good times. I hope we don’t get the 1929, the end. That said, you know, it would not surprise me to see some significant volatility in the overall market in the coming years because, you know, it’s been a very strong run in the last nine to 12 months and we can’t continue on this trajectory. But the overall long-term outlook still remains pretty positive, but I think we’ll probably take some pauses here and there, and I think that’s probably where I’ll leave it.
Chetan Sehgal: Sir John Templeton said that bull markets usually end on euphoria. And I think that is still something which holds true, that when the market is irrational, over-exuberance, there’s a euphoria in the market, there’s a good chance that we are close to a peak.
As Grant mentioned, that may still be a correction. There may be volatility, and therefore you have to reaffirm yourself. Do you really believe in these structural and sustainable stories? And that’s where we do most of our work. But there could be a time when there’ll be more volatility in the market. And typically, when there are so many participants and there’s so much liquidity, average holding period of the stocks is so low, there’s a lot of daily trading volume, you know that you’re close to some kind of a euphoric top. So, one needs to be careful, and one needs to be very, very sure as to what companies one is invested in and why one is invested in those companies and I think that is the only way to work out the pains which volatility will bring upon us.
Alistair MacDonald: So, leading on very nicely from that question regarding the risk of a bubble in US tech stocks, in particular. Grant, how would you address what some would call, you know, very elevated valuations at US tech companies?
Grant Bowers: Technology stocks definitely trade at a premium to the broader market, but I think we have to keep in mind that many also deliver faster growth, higher cash flows and generally higher returns on investment. Many of the technology companies in the market today are very profitable with very long runways of growth, meaning when you think about them and value them on a long-term discounted cashflow, you’re able to input some very good or reasonable growth rates over a very long period of time, which supports this valuation. So, I wouldn’t call it a bubble, and I would even push back on that. Broadly, that technology itself is not overvalued, giving its very strong earnings contributions to the overall benchmarks, as I mentioned, its higher levels of profitability, and it’s well above sort of market average, sort of, growth rate outlook in the next three, five, and probably 10 years. It doesn’t mean a few areas of the market are not expensive. We’re seeing some very speculative action in a few areas where I guess I would call it a combination of cheap financing, excessive hype on social media, and very thinly traded equities are seeing some incredible sort of moves in the markets recently.
Alistair MacDonald: So, has the outcome of the recent US elections with Biden winning the presidency and the Democratic party controlling both houses [of Congress], has this changed your outlook on the markets?
Grant Bowers: You know, we don’t see this as any real fundamental change to our generally positive outlook on US equities. And I think, while we did have a blue wave or Democratic control, it’s a very slim margin. It’s going to force both sides to the middle for any real legislative change. So, we expect there will be some incremental change, some undoing of the Trump, sort of, low-tax, low-regulatory environment, but generally no major changes.
Something that I think is important to mention is we think there’ll be some very significant changes in spending priorities, and that will start to shine and create some opportunities, alternative energy, electric vehicles, health care and technology.
And, you know, to bring it back to technology, one of the things I think we’re going to see from the Biden administration is a significant infrastructure bill with spending. A lot of that will be focused on the traditional roads and bridges and airports. But in this new, sort of, millennium, we’re going to see a lot of money go into things like broadband access, 5G infrastructure, other areas of technology that’s going to be very supportive and be very different than past infrastructure spending plans.
Alistair MacDonald: Excellent. Thank you very much, again: Grant Bowers, Chetan Sehgal.
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