Sometimes it pays to take a big step back, particularly at times of market uncertainty. This gives the opportunity to put near term concerns into a broader context. At the moment, the market has pivoted from Covid worries to Putin concerns. Taking a longer-term perspective can enable a more considered navigation of such events. Basically, you don’t want to overturn a strong long term theme because of some shorter term concerns or get driven into positions that only work during the tumult.
So what do we think will be a long term drivers of the global economy over the coming years? For one, we think the energy transformation theme will persist. Most western governments are committed to moving towards renewables. As a result, they continue to make new fossil fuel investments more difficult and subsidise renewables. However, in the absence of large-scale energy storage, one of the effects is to drive up the price of energy for consumers and fuel the demand for raw materials.
Another trend which is unlikely to reverse, is the growth of the emerging consumer. Emerging markets have been overlooked in the past decade, as the market became very focussed on growth stocks in the US. However, the middle classes in these economies will continue to grow. They are less impacted by the energy price inflation in developed economies, as their economies are still reliant on cheap fossil fuels. At the same time, they continue to expect an improving standard of living, fuelling demand for consumer goods, food, housing and so on. This in turn will create further demand for raw materials and energy.
One last trend to mention today, which we think will persist, is the ESG movement. Its impact has been, and will likely remain, material on corporate and investor behaviour. A consequence of this has been a considerable reduction in investment in some key industries, as commodity producers seek to massage their ESG ratings on behalf of demanding institutions.
The conclusion we draw from this is we are in a resource constrained world. Artificial constraints exist on the supply of energy and raw materials, through government and institutional action. These are reducing new supply across the board, not just in energy and metals, but further down the chain into other materials such a packaging and chemicals. Despite this, demand is expected to continue to grow because of renewable investment in the west and the emergence of new consumer markets elsewhere. In our opinion, the effect will most likely be higher inflation and squeezed margins for many industries and reduced discretionary spending for consumers in the west.
We feel comfortable with a portfolio that is heavily exposed to the beneficiaries of these long term themes. While interest rates are rising, the directly exposed growth areas will continue to be devalued. However, in the medium term, the direct beneficiaries will inevitably come back into focus. Therefore, a longer term portfolio exposed to a higher inflation environment but simultaneously having exposure to those advantaged growth areas is our preference. We think it remains sensible to avoid industries likely to suffer margin squeezes, such as industrials and consumer cyclicals. The squeeze is likely to be longer term than the market currently believes. Exceptions will be companies in those sectors which are clear beneficiaries of our designated growth themes.