The Horizon – Q4 Update

Our view of the post-pandemic world includes higher inflation, a rising Equity culture and an acceleration towards clean energy and automation. With 2021 in the rearview mirror, we believe that we are entering The Great New Dawn¹or our version of the beginning stages of a post-pandemic world. This era will contain some major pivots and further structural changes away from factors that dominated the pandemic cycle. It is our view that catalysts will begin to shift the economy toward increasing capital investment, normalized consumer spending patterns, less government stimulus, more regionalization in supply chains, and above-trend growth. Still, we believe a few key forces are likely to remain in place—the budding Equity culture should maintain momentum, despite elevated valuations and higher levels of inflation, with increased focus on secular growth areas of the future, including clean energy and automation.

We expect that the new Equity culture² that has been building for years will continue to grow as we move through the Great New Dawn. Equity market participation is at all-time highs as individual investors’ engagement with financial markets has recently surged amid the unique circumstances created by the pandemic, such as excess household cash, the favorable performance of Equities in recent years, and new platforms to access the markets. Individual investors have started to shape Equity market trends— they were among the biggest buyers during the pandemic recovery and have continued to pour money into the market when the opportunity has presented itself. In our view, the increased breadth of Equity market participation should continue to contribute to the secular bull market for years to come. Equity ownership is likely to increase further from here, as Equities will remain one of the most attractive options for investors, despite elevated absolute valuations.

Equity valuation multiples³ could compress a bit more this year, but it’s our view that they may remain high compared to their history given the new macroeconomic backdrop. The S&P 500 index should remain attractive to investors seeking long-term returns, as it has high exposure to companies and industries considered subject to secular growth. At the same time, U.S. Equities may be considered a high-quality asset class given their strong balance sheets and the resilience they displayed during the pandemic-driven recession, and they will likely continue to stand out amidst a global scarcity of assets, providing a combination of growth, quality and yield characteristics. Profit margins should also remain elevated for U.S. Equities due to an accelerated pace of innovation, justifying premium multiples. Finally, Equities look attractive relative to Fixed Income, their primary competing asset class for investor dollars.

Investors should also consider inflation’s impact on Equities⁴ when positioning for the years ahead. In our view, we are entering an environment characterized by higher levels of headline inflation paired with robust economic growth. Equities have generally powered through periods of rising inflation, but certain areas of the market may be especially primed to benefit, including shorter-duration, dividend-growth-oriented Equities with exposure to cyclical areas of the economy. In this sense, Value may be attractive. Small caps may also be poised to outperform, as they tend to have more exposure to cyclical areas that do well when the broader economy and inflation are strengthening. From a sector perspective, Financials can benefit if interest rates in the back end of the yield curve drift higher, and the Energy sector should get a boost from elevated commodity prices.

As inflation has gathered steam, energy prices have moved higher amid strong demand and tight global supplies, underscoring the importance of the clean energy transition⁵. The energy crisis has placed increased focus on the importance of scaling up the supply of renewable sources that are domestically generated rather than imported, available at zero marginal cost and not subject to global price shocks and supply chain disruptions. The transition will take time, and electrical grids will still need backup from traditional sources such as oil, natural gas, nuclear and even temporarily coal, to cushion supply-demand imbalances. In the longer run, however, policymakers are maintaining their commitment to decarbonization. The UN Climate Change Conference (COP26) concluded in November, with nearly 200 countries adopting an agreement to speed up the timeline for addressing climate change in the coming decade. From an investment perspective, clean energy and related materials, equipment and infrastructure should be principal beneficiaries as companies and countries look to reach their net-zero targets.

Investors may also want to look for opportunities within automation, as demand for robots⁶ gathers steam. A number of variables have recently converged to create unprecedented demand for labor, including the ‘Great Resignation’, lower labor force participation rates, educational mismatches, and coronavirus fears. But even before the pandemic, demand for robots, artificial intelligence and automation in general was accelerating in the face of a shrinking global labor force and tougher immigration rules and regulations. We believe the move toward automation is a strong secular theme with plenty of runway for future growth—International Data Corporation (IDC) estimates digital transformation investment for corporations will grow at a 15.5% compound annual rate over a multiyear growth cycle, reaching $6.8 trillion in 2023. For investors, we continue to favor automation companies across both the manufacturing and process automation spectrums.

On balance, it’s our view that investors should keep these considerations in mind as we move through The Great New Dawn and beyond. From a portfolio positioning perspective, we expect that the macroeconomic backdrop should remain supportive of Equities, and that investors may want to focus on inflation beneficiaries that offer a balance of yield and quality. Areas in which we expect secular growth will likely continue to gather steam, and we suggest incorporating exposure to clean energy and automation into well-balanced portfolios, when appropriate.