Author:
Robert St Clair
Head of Investment Strategy, Fullerton Fund Management
3 September 2024
Fullerton’s “3i’s” investment theme underpins our bullish outlook for global risk assets, focusing on Industry 5.0, Innovation and Involution - key drivers posed to significantly boost overall corporate performance over time.
1. Industry 5.0
Industry 5.0 is the next evolutionary phase in the trajectory of industrial development. While new technologies such as AI and related technologies may take some time to reach the peak of their utilisation and impact, we believe that when the technological advancements and scale reach a tipping point at about 2030, the transformation anticipated with Industry 5.0 carries with it the potential not only to redefine productivity and efficiency but to spur the creation of innovative products and services.
The waves of industrial revolution
Source: Bank of America, "Me, Myself and AI", February 2023
What new-tech can create:
Higher revenues + cost savings = greater earnings
For example, corporate revenue can rise over time because infotech can drive a more rapid transmission of ideas, enhance e-commerce, and facilitate the production of higher-value added goods and services for consumers. Significant cost savings can be created as infotech increases automation and efficiencies. In turn, higher productivity can reduce raw material demands, costs of production, and better align wages to workers’ value creation.
2. Innovation
Our second ‘i’ – Innovation, speaks to the breakthroughs initially sparked by Industry 4.0 - automation, cloud computing, machine learning and IoT. These technologies are set to receive a further boost from Industry 5.0, especially across tech-savvy nations such as the US, Japan, and Germany, which have in recent years seen substantial benefits in terms of enhanced productivity, cost efficiency, and higher than otherwise earnings.
3. Involution (i.e. the Great Decoupling of China)
The last of our thematic 3i’s is ‘involution’, which reflects China’s longer-term headwinds as it searches for policy solutions to end weakness across the real-estate sector, resolve economy-wide deflation pressures, and boost corporate performance. With a trend decline in potential GDP growth, policymakers’ strategy has been to channel rising per capita incomes to try and boost the domestic economy with stronger consumption. But such rebalancing is proving a slow process.
What this means is that while China equities may not transform into a robust ‘trending market’ until its long-term headwinds are resolved, it can still offer cyclical alpha. For example, as we have seen over the last few years, growth stocks have struggled but value stocks have outperformed.
How 3i’s are collectively driving the ‘Great Decoupling’ since 2023
Key global equities
Source: LSEG Datastream, 29 August 2024
US equity market performance is broadening
The performance of the US equity market is showing an encouraging expansion, with an especially positive note being the sustained strength in earnings growth expectations. Since the end of the very positive Q2 (June) earnings season, S&P500 earnings growth expectations have crept higher, with the largest increases being across healthcare, materials and real estate. The Q2 reporting season showed that 80% of all US firms are still beating market expectations1, which further underpins the depth of robust market fundamentals. With all sectors having a large majority of firms beating expectations, this broadening of performance bolsters our bullish stance on developed market equities, particularly those within the US.
US S&P500 earnings growth expectations
Source: LSEG Datastream, 29 August 2024
Percentage of US S&P firms beating earnings expectations
Source: LSEG Datastream, 29 August 2024
Despite the inevitable slowdown in US growth from last year (where 2H23 growth was surging at 4.2%) with the Q124 slump (to 1.4%), growth has rebounded to a more sustainable 2-2.5% range2. Against this backdrop, we remain steadfast in our belief that the twin pillars of robust productivity and controlled labour costs will continue to underpin equity returns. Domestic consumption in the US is expected to remain strong, fuelled by healthy household finances enriched by the recent wealth boom. Looking from the supply side, the stronger US corporate investment should help enhance labour productivity gains over time.
Equity returns across key markets (YTD)
Source: LSEG Datastream, 29 August 2024
There are investor concerns of a potential bubble within the tech sector, sparked by what appears to be overwhelming exuberance towards the ‘magnificent-seven’ counters. Nevertheless, strong performance of the US tech sector is not new; the post-2010 landscape has evolved distinctly from the 1990s narrative.
Since the turn of the last decade, we've witnessed the earnings and returns of the US IT sector not just resonate with each other but also consistently eclipse the broader market performance (see below). With the August ‘flash crash’ sparking a dramatic sell-off, IT sector equity prices have fallen significantly. But they have not undershot their trend outperformance of the market. We believe that as IT earnings and return trends can remain synchronised over time it can potentially help reduce the risk of a bubble forming.
US IT sector performance (Nasdaq 100) vs. US equity market (S&P 500)
Source: LSEG Datastream, 29 August 2024
The resilience of the US equity market is further accentuated by the very high corporate profit levels and some degree of deleveraging post the COVID-induced recession, which has resulted in an increase in interest income from cash reserves. Consequently, net interest payments (as a share of earnings) by US corporations are touching record lows. This dynamic, among others, explains why the elevated interest rates haven't exerted excessive strain on US equity market performance.
Added to this, as we look towards next year, the prospect of improved liquidity conditions, as the Fed progresses through its likely rate cuts, should give an extra boost to sentiment among investors.
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Report issued: August 2024