A post-pandemic world, when it eventually arrives, will not be a return to normality. It will be the beginning of a new era. Certainly, some pre-COVID behaviours will return, but the COVID experience has permanently changed behaviours and accelerated innovation and adoption. How the world reassembles will resolve a great number of the questions facing markets today. After several strong years of performance, equity markets in 2021 faced renewed concerns about inflation, rising rates and overall valuations, and these concerns will persist in 2022.
As always, macroeconomics dominates headlines, but the investment opportunities rest at the micro level of individual companies. Unprecedented demand for goods meeting a gap in infrastructure investment created a supply crunch, but we see signs that some of the supply chain issues such as semiconductor shortages and port congestion have peaked and should ease into next year. Investors cannot realistically claim to be able to see the next inflationary pressure, however. Forecasts around inflation and interest rates are not productive.
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While we refrain from making predictions about interest rates, it is reasonable to believe that if the economic recovery and accompanying inflationary pressures remain on the same trajectory, we would expect to see an increase in interest rates. The strong equity market, with growth1 outpacing value2 for several years, reflected in part a low-rate environment. Investors are prepared to pay more for growth when rates are low. A reversal of that relationship, however, concerns markets. While the market has pockets of expensive stocks susceptible to an interest rate shock, we do not see widespread market excesses. Nor do we anticipate a rotation to value stocks if interest rates do rise. Traditional value sectors, such as financials and oil, may rally in the near term, but we still believe the market will prefer long-term sustainable growth.
The analogue-to-digital transformation
That pursuit of long-term, sustainable growth brings us to the more interesting micro-level discussion for 2022. Precise forecasts are foolish, but we can focus on the broad areas where we see ongoing change. The pandemic accelerated the analogue-to-digital transformation that will support growth in the digital economy for the coming decades. The shift is the foundation for the software and semiconductors that are the building blocks of the digital economy. We feel certain that the trend towards digitisation will continue into 2022.
The isolation of the pandemic and the rise of remote work supports the acceleration of the adoption of e-commerce, streaming services, digital payments and the accompanying need for cybersecurity. These trends will also drive greater penetration in sectors that so far have resisted the analogue-to-digital transformation. Financial services and health care could show an increasing pace of change and provide interesting investment opportunities.
Businesses must consider all constituents
Businesses will face hurdles post-COVID. COVID accelerated the challenges to physical retail and to legacy, on-premises technology. Businesses built around workers returning to offices will struggle. Business travel is likely impacted for some time, whereas the possibilities for longer term leisure travel have grown significantly as consumers leverage their abilities to work from anywhere. Broadly, we expect competitive barriers to entry to be even more dangerous to businesses. The digital economy lowers barriers for customers to move to new services and products. Trying to exploit a tight grip on a customer base becomes a riskier strategy in 2022 and beyond. Indeed, companies in 2022 must more than ever consider all constituents: employees, customers, suppliers, and society at large. They must demonstrate ‘non-zero-sumness’, a win-win concept where companies create more value than they take, and which defines the long-term path for a successful company.
In sum, the challenge for growth investors is not to predict rates or obsess over valuation. If rising rates reduce the value of growth, then our view is that investors should focus on where that growth is strongest and most enduring.
Our lens on the world – guided by the world’s unpredictability – does not rely on precise predictions of the future. As such it is ideally suited for an environment in which the global economy is transitioning from analogue to digital. We believe that companies exhibiting high levels of non-zero sumness and further enabling the multi-decade transition from analogue to digital will be set up for success, regardless of the upcoming economic environment. Furthermore, such companies will also maximize long-term outcomes for investors.
Denver-based NZS Capital manages more than $1 billion in assets and focuses on innovative companies that create more value for all their constituents – including investors, employees, vendors, the communities they operate in and the planet as a whole – than they take for themselves. NZS Capital has a strategic partnership with Jupiter Asset Management.
2 A value stock refers to shares of a company that appears to trade at a lower price relative to its fundamentals, such as dividends, earnings, or cash flow.
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