The COVID-19 pandemic has killed thousands, upended daily life, halted the economy and shattered asset valuations. While a pandemic may be new to most of us, market volatility is not. Shocks like these remind us why we rely on our investment principles and how important it is to have portfolios that are aligned with our clients’ overall plans and goals. This crisis has also sharpened our focus on what we do best: advising clients on which building blocks can help weather the storm, finding securities that are not reflecting their fundamental values, and identifying trends that will drive growth in the future. To help shed light on the current market environment, we’ve outlined below the key investment themes and “megatrends” that have emerged.
Durable trends for the coming years
A primary theme in our 2020 Market Outlook was how digital transformation and healthcare innovation can offer long-term opportunities, and could be less sensitive to the cyclical business cycle. This thesis is playing out and we expect it to continue.
Megatrends
Anastasia Amoroso:
My name is Anastasia Amoroso, Head of Cross Asset Thematic Strategy at J.P. Morgan Private Bank. The world as we know it has been upended by the recent COVID pandemic and left many of us wondering, what does the new normal look like? What is this world post-COVID going to be? The biggest takeaway is that COVID has significantly strengthened and accelerated many of the durable trends that were in place even before that. We like to call them megatrends.
So what is a megatrend? It is a trend that is going to change and shape, and disrupt our lives not only in the next couple of quarters, but in the next three to five years. So we are focused on three such megatrends in particular. Digital transformation, healthcare innovation and sustainability. Now these are not new trends, per se, and the sectors that are benefiting from them, tech and healthcare, have done quite well. So why do we think these sectors and stocks are going to continue to deliver outperformance?
These megatrends are helping fuel double-digit earnings growth for parts of tech, biotech and clean energy sectors. And what we found is that, all else equal, these well above benchmark growth rates is what tended to drive long-term outperformance. And we take it a step further. It may be that, very near term, a lot of optimism has been priced in, but the longer term, we think not enough optimism has been priced in.
This is because while industry forecasts are ambitious, company and analyst estimates tend to be quite conservative. Let me give you a few examples of what we think is yet to be priced in but could lead to lasting outperformance of tech, biotech and clean energy. We know that in technology, growth and data is the most prominent trend in technologies. Like cloud computing, ultra-fast 5G and artificial intelligence are helping us capture this trend. But we’re still so early in the very early stages of these technologies.
For example, 5G smartphone adoption may reach only 15% by the end of 2020. The [inaudible 00:02:01] option of the cloud is running at only 20%, although this is being significantly and rapidly accelerated due to COVID. And for artificial intelligence, only 20% of enterprises have adopted AI at scale. So the opportunity to scale up these technologies is immense. And by the way, not to mention new technologies like augmented reality, remote surgery or autonomous driving that the former technologies will help enable.
In fact, enterprise adoption of 5G is a potential $700 billion opportunity for service providers, yet to be captured. And artificial intelligence is a $60 trillion opportunity to add economic value by 2030, also yet to be captured. In healthcare, innovation is certainly not new. But the speed of it is. In 2003, it took 13 years to complete the first reference sequence of the full human genome. Today, we can sequence a genome in less than 24 hours.
The other thing that’s really interesting in healthcare is that there’s this confluence of breakthroughs in genetics and artificial intelligence that is incredibly powerful, and it is further accelerating basic innovation. So is all of that captured evaluations? We don’t think so.
Given the current level of R&D, we can see $255 billion in additional industry revenues by 2024. If that pans out and half of that accrues to biotech, the revenues of the NASDAQ Biotech Index will almost double from today’s levels. This is not yet enterprised today, but will be in the future as drug approvals go from concepts and probabilities to certainties and realities. This robust pipeline of new molecules is fueling 27% average growth rate through 2022, and this is why we think biotech has a chance to break out of this five-year trading range and break out to the outside.
Sustainability will be one of the defining movements of this decade. How can we make the most efficient use of our natural resources while minimizing the damage to the environment and ensuring everybody has access to basics like food, water and clean air? That’s what sustainability is about, and more. We’ll consider that only 26% of our global energy mix today is from renewables. Only 9% of our companies and governments are designed for a circular economy.
The opportunity to increase this percentage is immense. Now this has been well telegraphed, but looking back at prior forecasts, we find that, time and time again, the actual adoption, the actual increase in renewables generation outpaced those forecasts. And that was when the cost of wind and solar was higher than it is today. We’ve seen that fall significantly. And now it is becoming not only a responsible decision for companies to adopt to move to circular concepts and clean energy concepts, but it is also increasingly becoming an economic decision.
So we think it is likely that the speed of adoption of sustainability practices like clean energy will [inaudible 00:04:56] to the outside, ultimately helping drive those stocks’ outperformance. Thank you so much for your interest in this topic. This is just a start. We will continue to update on upcoming developments and new technologies like augmented reality, remote surgery, precision health, circular economy, food tech and much, much more. So we look forward to working with you in finding investment opportunities within each one of these megatrends.
Side note:
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Text on screen:
Megatrends. Which sectors are poised to outperform in the next decade?
On screen:
An executive with long blonde hair and green eyes, Anastasia Amoroso, speaks to us remotely.
Text on screen:
Anastasia Amoroso, Head of Cross Asset Thematic Strategy, J.P. Morgan Private Bank.
Ms. Amoroso:
My name is Anastasia Amoroso, Head of Cross Asset Thematic Strategy at J.P. Morgan Private Bank. The world as we know it has been upended by the recent COVID pandemic and left many of us wondering, what does the new normal look like? What is this world post-COVID going to be? The biggest takeaway is that COVID has significantly strengthened and accelerated many of the durable trends that were in place even before that. We like to call them megatrends.
So what is a megatrend? It is a trend that is going to change and shape, and disrupt our lives not only in the next couple of quarters, but over the next three to five years. So we are focused on three such megatrends in particular: digital transformation, healthcare innovation and sustainability. Now these are not new trends per se, and the sectors that are benefiting from them, tech and healthcare, have done quite well. So why do we think these sectors and stocks are going to continue to deliver outperformance?
These megatrends are helping fuel double-digit earnings growth for parts of tech, biotech and clean energy sectors. And what we found is that, all else equal, these well-above benchmark growth rates is what tended to drive long-term outperformance.
On screen:
A bar chart appears, labeled "Tech and Biotech have cumulatively (though not always consistently) outperformed over the past two decades." The chart shows:
SPX at about 0.5% between 2001 and 2005;
SPX at about 3% between 2006 and 2010;
SPX at about 2% between 2001 and 2010;
SPX at about 12% between 2011 and 2015;
SPX at about 13% between 2016 and 2019;
SPX at about 6%, overall, between 2001 and 2019.
Tech at about negative 3% between 2001 and 2005;
Tech at about 10% between 2006 and 2010;
Tech at about 3% between 2001 and 2010;
Tech at about 13% between 2011 and 2015;
Tech at about 24% between 2016 and 2019;
Tech at about 10%, overall, between 2001 and 2019.
Biotech at about 7% between 2001 and 2005;
Biotech at about 0% between 2006 and 2010;
Biotech at about 2.5% between 2001 and 2010;
Biotech at about 35% between 2011 and 2015;
Biotech at about 2% between 2016 and 2019;
Biotech at about 11%, overall, between 2001 and 2019.
Side note:
Small print text appears.
Text on screen:
Source: Bloomberg Finance L.P., FactSet. As of May 1st. 2020.
Ms. Amoroso:
And we take it a step further. It may be that, very near term, a lot of optimism has been priced in, but the longer term, we think not enough optimism has been priced in. This is because while industry forecasts are ambitious, company and analyst estimates tend to be quite conservative. Let me give you a few examples of what we think is yet to be priced in but could lead to lasting outperformance of tech, biotech and clean energy.
Text on screen:
Digital Transformation.
Ms. Amoroso:
We know that in technology, growth and data is the most prominent trend in technologies. Like cloud computing, ultra-fast 5G and artificial intelligence are helping us capture this trend. But we’re still so early in the very early stages of these technologies. For example, 5G smartphone adoption may reach only 15% by the end of 2020. The enterprise adoption of the cloud is running at only 20%, although this is being significantly and rapidly accelerated due to COVID. And for artificial intelligence, only 20% of enterprises have adopted AI at scale.
On screen:
A bar graph labeled "We are still in early stages of adoption of new technologies" shows the adoption rates for 5G, cloud, and AI.
Text on screen:
Small print text: Source: "Global Handset Model," J.P. Morgan North America Research. March 2020. "Cloud Adoption to accelerate IT modernization." McKinsey 2018. "Talent and workforce effects in the age of AI." Deloitte. March 2020.
Ms. Amoroso:
So the opportunity to scale up these technologies is immense. And by the way, not to mention new technologies like augmented reality, remote surgery or autonomous driving that the former technologies will help enable. In fact, enterprise adoption of 5G is a potential $700 billion opportunity for service providers, yet to be captured. And artificial intelligence is a $60 trillion opportunity to add economic value by 2030, also yet to be captured.
In healthcare, innovation is certainly not new. But the speed of it is. In 2003, it took 13 years to complete the first reference sequence of the full human genome. Today, we can sequence a genome in less than 24 hours. The other thing that’s really interesting in healthcare is that there’s this confluence of breakthroughs in genetics and artificial intelligence that is incredibly powerful, and it is further accelerating basic innovation.
So is all of that captured evaluations? We don’t think so. Given the current level of R&D, we can see $255 billion in additional industry revenues by 2024. If that pans out and half of that accrues to biotech, the revenues of the NASDAQ Biotech Index will almost double from today’s levels.
On screen:
A bar chart appears, labeled "Sales should rebound, orphan drug market to almost double." It shows values, in 2018, with Prescription, excluding generics and orphan, at about 600 billion US Dollars; Orphan, at about 700 billion US Dollars; and Generics, at about 800 billion US Dollars. (The chart shows that this represents a slight increase in a steady market, since 2010.)
The chart also forecasts sharp growth. It projects, by 2024: Prescription, excluding generics and orphan, to be nearly 800 billion US Dollars; Orphan, to be about 1000 billion US Dollars; and Generics, to be about 1100 billion US Dollars.
Side note:
Small print text appears.
Text on screen:
Compound Annual Growth Rate, 2019 to 2024: 6.9%.
Source: "World preview 2019, Outlook to 2024," EvaluatePharma Vision. May 2019.
Ms. Amoroso:
This is not yet enterprised today, but will be in the future as drug approvals go from concepts and probabilities to certainties and realities. This robust pipeline of new molecules is fueling 27% average growth rate through 2022, and this is why we think biotech has a chance to break out of this five-year trading range and break out to the outside.
Sustainability will be one of the defining movements of this decade. How can we make the most efficient use of our natural resources while minimizing the damage to the environment and ensuring everybody has access to basics, like food, water, and clean air? That’s what sustainability is about, and more. We’ll consider that only 26% of our global energy mix today is from renewables. Only 9% of our companies and governments are designed for a circular economy.
The opportunity to increase this percentage is immense. Now this has been well telegraphed, but looking back at prior forecasts, we find that time and time again, the actual adoption, the actual increase in renewables generation outpaced those forecasts. And that was when the cost of wind and solar was higher than it is today. We’ve seen that fall significantly. And now it is becoming not only a responsible decision for companies to adopt to move to circular concepts and clean energy concepts, but it is also increasingly becoming an economic decision.
On screen:
A line chart appears, labeled "Cost of wind, solar, natural gas, and coal." It shows:
Wind's levelized cost of energy at 135 in 2009 and at about 42 in 2018;
Wind's dollar per megawatt hour at about 375 in 2009 and at about 5 in 2018;
Solar's levelized cost of energy at 130 in 2009 and at about 42 in 2018;
Solar's dollar per megawatt hour at about 375 in 2009 and at about 40 in 2018;
Natural gas's levelized cost of energy at about 84 in 2009 and at about 60 in 2018;
Natural gas's dollar per megawatt hour at about 150 in 2009 and at about 75 in 2018;
Coal's levelized cost of energy at 110 in 2009 and at about 105 in 2018;
Coal's dollar per megawatt hour at about 260 in 2009 and at about 250 in 2018.
Side note:
Small print text appears.
Text on screen:
Source: Lazard, Bloomberg, J.P. Morgan Asset Management. LCOE is "levelized" cost of energy, the net present value of the unit cost of electricity over the lifetime of a generating asset.
It is often taken as a proxy for the average price that the generating asset must receive in a market to break even over its lifetime. Data is based on availability as of November 30th, 2019.
Ms. Amoroso:
So we think it is likely that the speed of adoption of sustainability practices like clean energy will surprise to the outside, ultimately helping drive those stocks’ outperformance. Thank you so much for your interest in this topic. This is just a start. We will continue to update on upcoming developments and new technologies like augmented reality, remote surgery, precision health, circular economy, food tech, and much, much more. So we look forward to working with you in finding investment opportunities within each one of these megatrends.
Side note:
Legal disclosures appear.
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Digital transformation and tech-enabled innovation
The COVID-19 crisis has likely accelerated the move toward a digital-first economy and we don’t see this momentum slowing. Investing with experienced managers who have expertise in digital disruption and innovation offers return potential.
Healthcare innovation
The past several months have demonstrated the strategic importance of healthcare services and innovation globally. In fact, it’s likely that healthcare innovation will provide the resolution to the pandemic. We believe investing with healthcare-focused managers who have in-depth medical and scientific knowledge may offer the best means to capitalize on this megatrend.
Sustainability and Environmental, Social and Governance (ESG)
The unfolding health crisis and mass demonstrations surrounding systemic racism and inequity in the United States have sharpened our focus on ESG issues in investing. The world needs to make changes, and our investments can align with those trends.
Navigating volatility
Even though we are in the early stages of recovery, there is still no “all clear” sign for risk assets. The outlook remains uncertain—and uncertainty breeds volatility. Valuations are high and corporate debt levels have only increased. Understanding this, we recommend a focus on traditional and alternative diversifiers while keeping some dry powder in order to take advantage of sell-offs.
Pillars
Portfolio insulation
We believe that traditional diversifiers, such as core fixed income and gold, as well as hedge funds with less correlated return streams, can serve as portfolio buffers.
High-quality growth exposure
Dividend payers, companies with strong balance sheets and participation in lower-beta strategies can help protect capital on the downside while allowing participation on the upside.
Capitalizing on volatility
Volatility can create opportunities, and investors with capital to deploy may be rewarded when volatility results in value. We see opportunities ahead in structured notes, real estate and through proven active managers who can quickly reposition portfolios.
Finding yield
With continued policy support from governments and central banks, we see little reason to expect rising inflation. So yield-seekers are faced with the same challenges that characterized the recovery from the Financial Crisis. We prefer an active approach to both short- and long-term fixed income investments, given exposure to interest rate risk and the unfolding default cycle.
Pillars
Opportunities for short-term liquidity
Global central banks acted swiftly to lower interest rates to support the economy—and demand for safe havens from investors also drove down yields. Central banks will likely continue to be supportive, keeping policy rates low and maintaining asset purchase programs. Given this backdrop, it’s important to revisit strategic cash balances and consider other means to maximize yield.
Opportunities for longer-term liquidity
If you have excess cash, we believe opportunities in high-quality municipals and corporates as well as in select cross-over strategies can offer meaningful yield increases over cash.
Enhanced yield
To add to yield, look to assets that have an attractive spread over sovereign yields—upper-tier high yield, preferred equities and select emerging market and municipal bonds. Be open to expanding your toolkit to include assets outside of traditional fixed income, such as private credit and real estate.