Inflation Ahead, but Tech Trends Will Persist No Matter What
By James Cakmak and Ryan Guttridge
There has been nothing ordinary about the markets this year. In the face of unprecedented uncertainty, the broad market indices have gone virtually straight up for over a year. Investors have ignored massively depressed earnings, election uncertainty, and a widely changing regulatory environment and pushed stocks higher.
If there’s any silver lining to Covid, it’s that it accelerated the implementation and adoption of technological trends. Behavioral changes that would have unfolded over a period of years were forced upon us in a matter of months.
These productivity enhancements will not reverse once Covid is behind us. Even uncertainty around tax frameworks, antitrust legislation, inflation and interest rate movements won’t derail these technological trends. The one caveat that remains is the ever-present geopolitical risks with China.
People were always aware of the explicit out of pocket cost of goods and services. However, they have now been awakened to the implicit cost reduction created by cloud-driven online experiences. We all love to save time.
The challenge is that many companies are operating in markets where the overall level of demand will be lower. For instance, with regard to airlines, what’s the new level of business travel? How much office space does JP Morgan need with employees demanding a better work-life balance?
On the flip side, is there any question Amazon is better positioned today than it was 12 months ago. What company can afford to not operate virtually, at least to some extent? Certain companies will not only benefit from these cost savings but also materially improve their profitability through “additive manufacturing”.
Life will return to some type of new normal, but the playing field has dramatically changed.
As a result, the broad market may struggle as these “disruptors” move into the index and the relative importance of other segments decline. In fact, this is no different than what we saw back during the turn of the 20th century as the steel companies that built the railroads were eclipsed by the companies that used them.
Simply take a look at market returns during this era as illustrated in Alasdair Nairn’s Engines that Move Markets:
So the question becomes how do you invest in this paradigm?
During these periods, historically speaking, the broad market has supplied below average returns as this multi-year transition takes place. Therefore security selection and appropriate position weighting is paramount to outperformance.
On the bright side, this doesn’t mean there are no winners. In fact, Ford, the inventor of the productivity booming assembly line, delivered a compound annual return of 56% from 1903 to 1926.
As such, the securities that command a disproportionate amount of the returns during this next chapter should come from one of the following three buckets:
- The New Utilities. What are the companies that are absolutely essential to the world today? In other words, what are the new utilities?
- Adaptive Legacy Manufacturing/Services. What are the companies whose business models and economics will benefit the most from adopting the latest technology while maintaining their relevance in this different economy?
- Cloud Leveragers. What new companies are best positioned to drive these behavioral shifts further? Which companies can best leverage the established cloud infrastructure to redefine old and create new markets?
It’s mission critical not to be caught in value traps during this period of transition. A value trap is defined as a company which has “cheap” valuation metrics relative to the peer group but cannot sufficiently adapt to new trends and behavioral patterns. On the flip side, established companies that are “cheap” metric wise but whose sustainability is not threatened represent the real value plays. Add to that the ability to improve operations through utilization of these new technologies, there is potentially massive upside.
The caveat is the potential for systemic shock remains elevated, whether it be in the form of escalating inflation, interest rate hikes, or heavy handed tax policies. Inflation particularly is a material area of concern as the economy reopens. It’s virtually impossible to avoid a bottleneck on the supply side when you open the economy with the flip of a switch. Think of it like a traffic accident where the accident is cleared yet the traffic jam remains. During these times, elevated cash balances and/or some combination of tail risk hedging is a must.
Longer term, technology can and will always move forward. Betting on the winners in the highlighted areas, and doing so in size, should continue to yield outsized performance relative to the major market indices.
Clockwise Capital is an asset management firm with a private equity approach to the public markets. We focus on the meaning of time and the role it plays in people’s lives. We believe the essence of a great investment resides in the ability of a company to either save their customers time, or improve its quality. We understand how technology evolves to drive these two factors, which we believe define human progress. As a result, we search for securities with cyclically depressed valuations whose companies save time, thus using secularly advantaged industries to build a concentrated portfolio. With each series of investments our goal is to optimize edge, maximize return, while also minimizing correlation. This allows our portfolio to maintain a liquid, low duration fixed income balance, ready to capitalize on market volatility, while still generating market beating performance.
