To say that 2020 was rich with excitement and surprise is a bit of an understatement; it will go down in history as one of those years that felt like a decades-worth of action - socially, economically, and financially. And yet, there were a few developments of consequence that slipped under the radar as the more spectacular and noisy events of the year, like COVID, the US presidential election, and Brexit took up all the bandwidth. I’d like to share three trends – mostly with illustrations – that I consider long-term “mega-trends” that did not start with the pandemic but were accelerated by it.
Over the past decade, a number of mega-trends have gained momentum, changing the fabric of our lives and our societies in far-reaching ways. While much of the spotlight in 2020 was focused on the media’s favored spectacles, three mega-trends have moved ahead unabated and have even picked up steam during, and due to, the pandemic:
Digitalization and technological innovation
The rise of the East
Big government, bigger debts
I consider these three mega-trends to be amongst the biggest and, for us investors, the most noteworthy driving forces to consider as we bravely venture forward into this young decade.
The acceleration of digitalization and technological innovation
We have all experienced first-hand how our use of new remote communications and co-working tools picked up during the lockdown periods. From Zoom to Teams and Slack, we all learned to more effectively and efficiently employ these new technologies. However, these tools are only one of the many areas in which the fourth industrial revolution continues to advance at an ever-increasing pace.
We also learned how much power social media platforms have in influencing public opinion, sensationalizing developments, and feeding our worst instincts with a focus on binary arguments and click-bait driven news. While man has never had more sources of information and the means to express their opinions, the current media model tends to focus on the sensational over the newsworthy. It acts as a divisive force that stirs and spreads controversy, rather than the fountain of basic common understanding of important developments. Mental bandwidth overload from an increasingly noisy and partisan ‘public square’ leads many away from independent thought and common sense, as they either retreat into self-censorship or jump into the melee of digital conflict, abandoning all appreciation for the basic values most people share and focusing only on what divides us. This is not a recipe for a constructive dialogue on the many challenges we face, and for some, it has become a lucrative business model. We need to do better.
However, technological progress has also underpinned the evolution of our economies and societies for centuries and most of the innovation unfolding before us is amazing and could have a very positive impact. Away from all the ‘noise’, real leaps are underway. According to research by Quant IP, the following achievements quietly unfolded while the world was focused on the ‘click-bait’-driven doom and gloom of 2020:
“Elon Musk's space company Space X has made a total of 26 operational rocket launches in 2020, and the rocket has landed 23 times. Already 900 small satellites of the program Starlink are in orbit, which will offer fast internet for the most remote areas of the world. A machine learning algorithm predicted the folding of proteins with a hit rate of 90 percent. This is likely to greatly accelerate the development of drugs for many diseases, including cancer. US company QuantumScape has released test data on its solid battery, which could be a breakthrough for battery-powered cars. In 3 years, an incombustible battery is to go into mass production, which can be charged in 15 minutes to 80 percent, allows about 50 percent more range and still has 80 percent capacity after 800 charging cycles.”
These examples stand testimony to the rapid advances of technology, and the fast arrival of a very different world than the one we have been used to.
Some of all this is exciting. Some of it is daunting. Whichever way you look at it, however, rapid and deep technological change is here…and here to stay. As we shift from the old economy to a new economic model, value has moved from the tangible to the intangible, or a combination thereof. The ascent of tech firms since the 1990s has brought about a massive change in the asset mix of publicly traded companies, with the share of intangibles currently at unprecedented levels. The following infographic charts the growth of intangible assets in the S&P 500 over time, providing a glimpse at how prevalent technology has become in our lives. Moreover, as shown then in the second infographic, a handful of tech companies make up the vast majority of the value of the Nasdaq index.
The Soaring Value of Intangible Assets in the S&P 500
Source: Visual Capitalist
While technological innovation has always proven to be the driver of paradigm change and often a productive and positive challenge to the status quo, the ‘winners’ of the last decade have been tech businesses built upon the powerful foundation of the internet and the network effect. The network effect tends to lead to near monopolies in each sector, as the early mover that manages to scale can establish a level of control at a rapid pace unseen before in history. This has brought great consumer experiences and productivity to business, but it has also created a handful of very powerful entities with little oversight and with control over the ‘oil’ of the digital economy – all our data. The illustrations that follow highlights these trends.
The Nasdaq’s value is dominated by a handful of tech companies (in US dollars)
Source: The BBC
In recent years, much has been said about China and the need for the US and the West to decouple from it. However, a look behind the headlines over the last 2-3 decades clearly shows that China and Asia have long been working to establish independence from Western finance and technology, and to harness global trade as a means of bettering the lives for their people and growing their economies and position in the world. I did a 100-page plus report on these dynamics with some of my distinguished research partners a few years back, which I am happy to share with people seeking a deeper dive.
Here, we will just briefly look at some of the key findings via a few illustrations. The first illustration that follows clearly shows the shifting power of global manufacturing and the transportation infrastructure.
The shifting power of global manufacturing seen via the World's top shipping hubs over the last 15 years.
Source: Visual Capitalist
Here is a look at the changing dynamics over the long arch of history in market capitalizations of the continents. While it is not a perfect lens, it is instructive on the direction of financial power.
Market Capitalization Share by Continent
Source: Global Financial Data
In my view, China is often misunderstood by investors – bullish and bearish alike – and as it is a key cog in the global economy, and increasingly, in the financial markets, that is clearly sub-optimal. Even if you do not invest directly in China, its position as the world’s top trading nation, a major player in global financial markets, and increasingly, a driver of technological innovation, makes it a key factor that investors need to consider.
However, most analysis is often "all trees and no forest" - or vice versa - and biases abound, or as the good people at Macropolo put it: "In this exceptional year, much of our collective attention span was spent on the pandemic, the US election, geopolitical tensions, and social media paroxysms. When it came to US-China in particular, there simply wasn’t enough “China” as the bilateral dynamic was regularly filtered through the prism of the pandemic and the US election. Focusing on the daily rigamarole obscured subtler, and ultimately more consequential, developments. Stepping back at the end of 2020, we want to highlight two overlooked and two overhyped trends that, in our judgment, will matter greatly to China’s political economy and for how it adjusts to a dramatically changed external environment."
On the decoupling question, they go on to highlight that, "If a single word were chosen to define US-China in 2020, ‘decoupling’ would be a good candidate. Bandied about with abandon, the term has created the perception that these highly complex supplier networks were being severed in real time. What has been overlooked is just how little meaningful decoupling actually happened.”
“Foreign businesses are just one gauge of decoupling, but they are particularly important leading indicators of shifts in supply chain ecosystems. In 2020, the respective portions of US (87%) and European (89%) businesses indicating no intention to leave China are as high or even higher than they’ve been in recent years.
“And despite the Japanese government creating a fund to help re-shore its manufacturers, only 4% of Japanese businesses said they’re definitively leaving China. Pandemic disruptions certainly weighed heavily on firms’ decisions, likely delaying drastic changes or planned investment. It is also true that many companies want to diversify beyond China—some already have—to hedge against risk. Nonetheless, what has actually happened on the decoupling front appears disproportionately modest relative to the attention heaped on it."
To start 2021 with some insightful perspectives on China, I recommend that you read their short piece in full, as they look at two overlooked and two overhyped trends related to China:
In order to get deeper into the ‘undergrowth’ of the Chinese economy, I suggest you listen to this insightful conversation with one of my preferred China observers and thinkers, Michael Pettis:
As the following two illustrations below clearly show, Asia is a key component of the global economy, the source of most of the economic growth, and as such, it should be an important consideration for investors and a part of their portfolio.
Putting the global population under the ‘MacroScope’ shows you the importance of Asia…
Source: Washington Post
A look at ‘single-generation progress’ shows how far China and other Asian economies have come and why their consumers are key for businesses going forward.
Living standards will have at least doubled in many nations by 2025.
Source: Bloomberg analysis of IMF WEO October 2020 data / Notes: Generational living standards approximated by purchasing power parity-based GDP per capita from 2020 to 2025: details for BRIC nations and the U.S. are labeled
Big Government – Bigger DEBT…
I highlighted the following in a recent memo I wrote: “Total global debt is set to hit a record $277trln by the end of 2020 according to the IIF. They reported that the debt had already ballooned by $15trln this year to $272trln through September. Governments, mainly from developed markets, accounted for nearly half. The developed markets’ debt to GDP overall has jumped to 432% in Q3 2020 up from a ratio of about 380% at the end of 2019. Emerging market debt-to-GDP hit nearly 250% in Q3 led by China with 335%. These are levels you can’t earn your way out of. You can default outright, or you can enter the path of least resistance and debase your currency and keep rolling the debt.” We are already on this path and to execute this insidious debasement strategy of increased financial repression, governments will be tightening the controls.
As the floods of Central Bank liquidity, increasingly directed by the designs of central planners in our various bodies of governance, drown market forces, the heavy hand of government will be felt in all parts of the economy. Some of this is needed, at least short-term, and where it can be a more gradual public-private collaborative effort to guide our economies onto new and more productive path, it may turn out to be beneficial. However, as the temperature starts to rise, their efforts will at first be aimed at distracting the frogs that are currently still content sitting in lukewarm water. By the time we reach the boiling point, those still stuck in there will have no option but to stay put. These dynamics will play out over this decade, and investors best come prepared with an awareness that the lure of a day at the spa may turn into a bad scalding, or worse.
Beyond the debasement and the financial repression, big government and even bigger debt will also bring plenty of opportunity to those entrepreneurs and investors who can take a pragmatic approach, see through the smoke and mirrors, and identify the sectors that stand to benefit from all this largesse, deploying their efforts and capital accordingly.
A look at the projections for US debt and deficits is instructive for the scale of the problems…
The US deficits projected out to 2050 show both the extended period the government will continue holding a dominant role in the economy and the insidious effects of the compounding interest – even at these historically low levels - on the gigantic levels of debt. Hard choices will have to be made eventually.
Percentage of Gross Domestic Product
When you have slipped into a debt-based economy, all you can hope for is that the debt is deployed productively and that the economic output can keep up with the rising debt load. This illustration shows that for the US we are getting less and less bang for our buck…
Total US Debt vs. Nominal GDP, 1969-2019
Sources: BEA, Board of Governors
What is really needed is a boost in productivity through major technological innovation in core economic sectors. The next illustration highlights how the US economy has lost the vigor that set it on the path to success in the initial post-WWII period, and again in the 1990s as the internet was unleashed.
Average Annual Growth of Real Potential GDP
Source: Congressional Budget Office
For the last couple of decades in the US – the US, once the source of most of the major leaps in innovation – shifted its focus from taking on the big challenges to making minor incremental improvements to marginal and consumer-focused areas. It left the hard problems, be it in manufacturing or the energy transition, to others, namely Asia. It all became about financial engineering instead of real engineering as Silicon Valley and the US tech giants became content to increasingly venture out into the thinner and thinner branches of the innovation trees of the major leaps of the past – the semiconductor and the internet – without much appetite for taking on the truly paradigm-shifting challenges of the real economy.
Declining Productivity of Debt
Source: The Macro Strategy Partnership LLP
As mentioned, there are signs that this is starting to change. I have been keeping an eye on the amazing National Labs system of the US and various technology-focused institutions and businesses in the EU and Switzerland, and some really interesting work is being done there…work with the potential to reinvigorate the economy by taking on some of those hard challenges once again.
The key will be for some of all the trillions of fiscal stimuli to be effectively deployed in these areas. The nations that can balance the inherent debt and debasement strategy by making real and lasting improvements to their economies that sets them on a path to a new paradigm will be the winners of this decade and beyond. Investors should be focused on monitoring this area as it will lead to a generational wealth creation opportunity for those who get it right, while it also has the potential cut the other way and be a source of wealth destruction for those who get it wrong.
At BFI, we will continue to look for a sustainable balance in this space, managing the risks and harnessing the powerful dynamics for protection and gains.