Investors in global markets had a lot to absorb in 2024. Elections around the world dominated much of the public discourse during the year, coupled with ongoing geopolitical tension, set against a backdrop of frequently disappointing economic news. As a consequence, volatility flourished.
But taking a longer lens to the view we are afforded as the new year starts is perhaps much more revealing, especially to those wanting to build long term wealth. The picture that history reveals when it comes to equities is that markets have tended to move in decadal mega cycles, where one major ‘theme’ has dominated.
From an investment return perspective, being on the right side of these trends has been very rewarding. So, investors are understandably asking now: what themes can we expect to dominate over the next ten years and beyond?
A unique point in history?
A large proportion of equity returns over the last decade-plus have been generated by companies that have benefited from lower interest rates. This has led to very narrow market leadership from a band of asset-light, predominantly US-domiciled, mega-cap technology platforms.
Arguably, however, the past few years have witnessed the beginnings of a prolonged secular change, the scale of which we typically only see every ten to 15 years – a new era of higher inflation, higher rates and heightened geopolitical tension.
But what is particularly unique – and exciting for us as investors – about this current point in time is that there appears to be a confluence of several transformational and multi-generational shifts occurring simultaneously.
Disruptive force of Artificial Intelligence (AI)
From an investor’s perspective, one of the most attractive features of AI is that its ultimate addressable market is potentially limitless, given its pervasiveness across so many parts of the economy.
However, there is much analysis still to do. Determining the potential implications of AI, understanding what factors may accelerate or decelerate pace of adoption, and crafting a potential investment approach will be vital for investment success.
Our AI investment framework focuses on the following areas: compute (semiconductors, or the ‘brains’ of AI), infrastructure (cloud hyperscalers, data centres and networks, which provide the ‘plumbing’), AI model developers and software applications (embedding valued-added AI into software and charging a recurring premium), and finally the real-life and end-industry beneficiaries.
Most of the current hype is around two of these areas: real-life and end-industry beneficiaries, and AI model developers. And although beneficiaries in these areas are potentially enormous in scope, it is still too early to have definitive views given the high degree of speculation and wide range of possible outcomes.
As for AI model developers, the risk of potential commodisation is high, given a large and growing open-source AI community advocating the ‘AI for Humanity’ concept. This community has been highly collaborative in sharing research, ideas, coding and best practices. There will likely be a small number of winners in this space. Determining who they will be will come down to those owning the large data sets required to train AI models.
In contrast, there are significant potential long-term opportunities in companies providing the computational processing power and the infrastructure on which most AI workloads will run, and, very selectively, in software businesses that can successfully embed a value-added AI application into their systems and charge a recurring premium.
A significant difference to previous technology cycles is that the incumbents possess many first-mover advantages to deploy AI at massive scale. Large tech companies already have proprietary data, huge amounts of capital to spend and some of the brightest engineering talent. Some of them also own the cloud computing infrastructure necessary for training AI models. In addition, they already have massive user bases into which they can sell AI products and services. While there may be some AI startups that find success over time, the starting point for incumbents is strong, in contrast to previous cycles.
The genetic era of health care innovation
There is a strong argument that the world is entering a golden era of medical innovation, which will likely enjoy multi-decade tailwinds. Behind this is a substantial increase in the number of novel drug platforms, which is expected to accelerate the pace of drug innovation and discovery.
In particular, breakthroughs in genomic sequencing and data processing are allowing drug companies to research, develop, and apply specific and precise interventions for illnesses.
The confluence of these technologies and pace of innovation is paving the way to address large but, as yet, mostly untreated illnesses worldwide, including obesity, cancer, cognitive impairment and pain.
As this wave of healthcare innovation accelerates - the genetic era – it may well be transformative. Breakthroughs are enabling a deeper understanding of genetics and leading to the creation of highly targeted, interventions to tackle a wide range of genetic disorders. Examples of these treatments include RNA interference (RNAi), gene therapy and gene editing.
And what is very exciting as an investor is that this genetic era in health care innovation coincides with another transformational shift - AI.
Industrial renaissance
For much of the 15 years post-the GFC, which were characterised by ultra-low interest rates and bond yields, investors have focused on ‘growth’ companies - especially those long-duration, asset-light digital innovators and disruptors - and largely ignored more cyclical old-economy industrial businesses that make physical things.
Signs are emerging that the more cyclical, old-economy industrial businesses that make physical things may return to favour, driven by several multi-year trends. This sets the stage for the kind of capex supercycle not seen in decades. This could potentially drive earning of various well-placed industrial companies for years to come.
These may include companies at the forefront of the energy transition, energy security, the buildout of data centres, rising defence spending amid a heightened geopolitical risk environment, and the desire to reconfigure global supply chains.
Old-economy cyclical manufacturers could become critical enablers of the future economy and, in doing so, transform themselves into secular growth companies.
Enabling the energy transition
Growth in renewable energy has been a major investment theme for at least a decade thanks to declining costs and government commitments in the trillions towards infrastructure buildout.
While the initial energy transition focus has been on areas like electric vehicles, less visible but equally critical changes include better air-conditioning hardware, as well as more efficient methods of heating buildings.
Elsewhere, alternative fuels such as hydrogen will play an important role where electrification could be challenging, such as long-haul trucking or steel making.
What remains underappreciated in the ongoing transition to renewables is how transformative this trend could ultimately be for manufacturing and the broader economy. Unlike coal or natural gas, renewables have essentially zero variable costs and once infrastructure is built, there are only small maintenance expenses. This could collapse power costs and provide major competitive advantages to a range of manufacturers, from steel to textiles, to consumer goods to chemicals.
A further factor to consider is energy security, which has come into sharper focus in recent years.
Reconfiguration of global supply chains
Just as countries are seeking greater security around energy supply, many companies are improving the resilience of their supply chains by rebuilding them closer to home and end markets.
Recent geopolitical tensions and supply disruptions have caused many countries to reconsider the balance between efficiency and resiliency of supply chains, and the merits of cross-border complexity. Manufacturers have realised they need greater resilience, namely visibility into their supply chain, flexibility to change types of production, and remote monitoring. This has sparked a wave of reshoring or friend-shoring.
A subset of companies could be better placed to navigate these changes
A cohort of companies that has proved particularly effective in responding to the types of changes discussed here are multinationals.
Global multinational businesses typically are well equipped to deal with uncertainty and disruption. For the most part, they have strong and experienced management teams, capable of navigating different - even hostile - environments. They are also used to conducting business across the world, finding ways to succeed by responding effectively to local competition.
An unpredictable environment can often play to the strengths of multinationals, which have the expertise and resources to adapt quickly.
As we head into the new year, it is clear, then, that the next decade and beyond could present a rich and diverse set of investment opportunities for global equity investors.
But that also means it is important to find investment strategies that can navigate significant market shifts, while keeping true to their objectives and philosophy.
Matt Reynolds is an Equity Investment Director for Capital Group (Australia), a sponsor of Firstlinks. This article contains general information only and does not consider the circumstances of any investor. Please seek financial advice before acting on any investment as market circumstances can change.
For more articles and papers from Capital Group, click here.