Markets Weekly podcast – 4 April 2022

Julien Lafargue (JL): Welcome to a new edition of Barclays Private Bank Markets Weekly podcast. My name is Julien Lafargue, Chief Market Strategist at Barclays Private Bank, and I will be your host today.

As usual, we will first recap last week in the markets, but today we will keep this section relatively short and spend a bit more time discussing with our guest. Indeed, I’m delighted to be joined by my colleague Hiral Patel. Hiral is the Head of Sustainable and Thematic Investing within Equity Research at Barclays Investment Bank, and she’s joining us today to talk about the third edition of her flagship report on the 150 trends that will shape this decade.

But before that, let’s quickly run through last week’s markets action. There were more tragic images, unfortunately, coming from Ukraine over the weekend, but the military situation appears more or less neutralised, with Russian troops refocusing their efforts in securing dominance over the east and the south of the country. This, and the simple passage of time, means that investors’ focus is gradually shifting away from the conflict and towards the health of the global economy.

And so last week’s focus was really on the US and on the labour report. We showed that companies added 431,000 workers in March, despite everything that was happening at the time. But this remains a very late-stage indicator, and we had another piece of data that was less encouraging. The March manufacturing ISM, a more forward-looking indicator, was still pretty solid at 57.1, but it declined month-on-month and revealed a short downtick in orders, which is probably the most leading indicator in the survey. New orders dropped from 61.7 in February to 53.8, highlighting the fact that orders are coming at a slower pace than before.

Another source of concern last week was the shape of the US yield curve, which has now inverted between the 2-year and 10-year maturity. This is a very closely watched indicator, as historically it has coincided with upcoming recession. Now, as we’ve written about in the March edition of Market Perspectives, this indicator is not only imperfect, it also doesn’t help at all with timing. In other words, even assuming the yield curve is right this time, there could be months and significant additional positive returns for stocks between now and the next recession.

Nevertheless, this will likely stay on the back of investors’ minds and contribute to continued volatility in the coming months. That being said, the Federal Reserve is unlikely to change tack and the market is now pricing close to nine 25 basis point hikes this year, with many commentators calling for not just one, but, actually, a couple of 50 basis point moves before the summer. In fact, Barclays Investment Bank has updated its forecast to reflect these two 50 basis point moves in May and June this year.

This looks like frontloading and we would not be too surprised if the Fed decides to slow down the pace of tightening in the second half of this year. In the meantime, we believe it still makes sense to favour short and medium-term bonds in the current context. With that, let’s move on to what will matter in the next five to 10 years.

Hiral, thanks a lot for joining us today and I want to start our conversation by asking you a very simple question. Within the 2030 Thematic Roadmap you cover 150 trends. Obviously, this is a lot of different trends and different themes, and they’re probably not happening at the same time or at the same pace. So, within those 150 trends, which one do you think investors should be focusing on at the moment? And do you see some trends are gaining, and some other trends losing, momentum?

Hiral Patel (HP): It’s the million-dollar question. So firstly, the 2030 Thematic Roadmap was really originated for ESG and thematic investors looking for long-term investable opportunities. Now, a question I always get is, why 150? Why not 50? Why not 10? And I think we track the 150 trends because we really wanted to think about which of the trends will impact society by 2030, and we looked across various different sectors.

So we looked at what was happening in the technology sector, the consumer sector, industrials, energy, and healthcare. So, the 150 seems like a lot at first blush, but it does try to cover all of the different sectors. And we take various internal and external feeds so we get a really good idea of which of the trends are gaining or losing momentum, and which, in our view, is actionable for an investor, because something may sound interesting or cool, but it needs to be investable for a client and there needs to be a near-term catalyst.

So when I look at our 2030 Thematic Roadmap that has the 150 trends, there is clearly a big focus on decarbonisation. The number one focal area will always be trends which are related to climate change, and I think what’s really interesting is, especially given what’s happening broadly related to Russia and Ukraine, the discussion is extending beyond just saying, you know, we need to be using more renewable energy.

I think local governments are thinking about energy autonomy and thinking about what can we do to become less resilient on others when it comes to energy production and energy storage. I think another area within our roadmap where we’re seeing a lot of traction is the focus on broader environmental areas. I always say to my clients who are interested in launching climate change products, is, there is more to the debate than just carbon emissions. Think more broadly.

And one of the areas within that is natural capital and biodiversity. So I’m sure many of you may have seen a very popular Netflix series called Seaspiracy trying to raise awareness of the ocean economy. There’s similarly a lot of David Attenborough series relating to the future of soil, health, and agriculture, and as well as the bees. So we do think broad environmental areas, as well as energy autonomy, is one of the key areas that investors should be focused on.

Another thing our roadmap considers is, as much as I’d like to say, you know, climate change is the number one area, the roadmap also considers which of the trends may not be the biggest today, but could be the ones that are going to be gaining the most momentum over the next few years. And one really cool thing that we have in our roadmap is that we have data which shows which of the emerging trends of tomorrow, so the trends that are not necessarily the biggest today but have the most potential in our view to grow over the next few years. And there are three areas in particular that I think are very topical at the moment.

The first is supply chains, given all of the focus on logistics and fulfilment, as well as in that post-pandemic environment where people are thinking about a domestic resiliency or local manufacturing.

The second key area I’d highlight is advanced-construction materials. Now, I know that’s a pretty lengthy trend, but if we take a step back, there is a lot of regulatory momentum supporting the focus of smart buildings, sustainable construction, and we think the future of cement, concrete, bricks, windows, any materials that we need, will be a very interesting area for investment going forwards.

And then the third thing I would highlight is really the focus on circular economy. Now, I’m sure many of you who are listening today are probably thinking, Hiral, we’ve been hearing about recycling technology for many years now, and the reason I wanted to highlight this, is that clearly during the pandemic the focus on circular economy did take a step back, and we do see that returning where we think the future advanced chemical recycling, especially when it comes to really hard types of plastics which are hard to recycle, we do think that they are scaling and have the regulatory backdrop to now commercialise.

JL: So obviously monitoring 150 trends is a lot of work. The main question, I guess, is how do you assess the impact of each of these trends, and what are some of the catalysts or considerations you make when assessing which of those trends should be included in the roadmap from an investor’s perspective?

HP: Yes, it’s a big, big database of various internal and external data feeds. So, I mentioned that our 2030 Thematic Roadmap looks at 150 trends, and it’s essentially a scatter plot where we rank each of the 150 trends. Now, we rank them and we assess using two top parameters, likelihood and impact, and we selected likelihood and impact as our top parameters because we thought that would answer the question, to what extent would these 150 trends be visible to society? Now, when we think about impact there are various things we consider. The first is to think about the addressable market. What is the potential addressable market for each of these trends? Is this trend going to impact one sector, two sectors, or multiple sectors? Is it going to be a B2C opportunity or a B2B opportunity? So the first thing for us is always to think about the addressable market.

And then when we’re thinking about impact still, we think about what are the barriers to entry? Are there high barriers to entry influencing the number of companies present within a trend, because, for me, the number one thing when assessing the inclusion of a particular trend is the actionability. There is no point me mentioning a trend if there is not an end pool of companies, public or private, that investors can start to follow or potentially invest in.

So when we have a good idea of the addressable market, we then think about the companies, and in particular not just thinking about the number of companies but also thinking about the level of barriers to entry and the level of competition regionally, whether there’s more competition in Europe, the US, or in Asia.

Now, that’s on the impact side, but I think what’s really important for our listeners today is probably thinking about the likelihood, because when you’re thinking about all these trends and you’re thinking about all this new emerging innovation or changing consumer behaviour, it’s very easy to get convinced that this is going to have a real impact to society. But then the harder challenge is then thinking about the likelihood. How likely will this technology scale? Is there a scarcities factor? Is there a supply or demand dynamic that we need to consider?

And the number one thing that we can consider is the level of funding in each of these trends. And I think it’s really important for our listeners today, because it’s not just thinking about the public-listed companies. I actually think the most dynamic element of funding is probably happening on the private side, where we’re seeing not just a large range of unicorns, but also a smaller number of series A to series C or D perhaps, who are really driving the change. And it’s really important for me to follow these companies, because then I can see whether they have the potential to hopefully IPO in the future or whether they would like to stay private and gain additional scale in that way.

So, to answer your question, Julien, we consider a lot of things on the impact and the likelihood side, and once we do, coming back to what then gives us the highest level of conviction is the actionability of it, and that’s where we then think about if we had this potential pool of companies, how profitable or how scalable would these companies be in five years’ time or 10 years’ time. And a question I always get from clients is why do you think about 2030? Why not 2040 or 2050? For us, I think, 2030 it’s highly related to the UN Sustainable Development Goals where we’re having many of our clients creating impact strategies dedicated to that timeframe.

JL: This year’s update to your 2030 Thematic Roadmap has a particular focus on digital sustainability. Can you explain to us what does that mean for investors? And on the topic of digital sustainability, do you think there are additional costs or risk that investors should be focusing on when assessing technology trends?

HP: So we typically update the plotting of our 2030 thematic roadmap on a yearly basis, and each year we like to take a particular focus. So last year, with edition two, we were focused on the post COVID world, thinking about how our trends would be impacted by local economies reopening. And this year we focused edition three on digital sustainability.

Now, it’s quite a controversial topic or focus area that we’ve selected, because if we take a step back, many of the trends I’ve already mentioned rely on the ongoing digitalisation of society or the scaling of new technology. And as much as I think digital will continue to be a long-term enabler, for many of the trends within our roadmap, I sometimes feel that the narrative within the investment community often fails to fully consider the costs associated with digital. So as much as I love talking about agricultural tech, robotics tech, or health tech, I do think that the social or the environmental costs associated with digital also need to be considered.

And so what we did is we took a step back, we looked at all of our technology or digital trends and we started to think about it from an ESG perspective. We thought, OK, what type of environmental or social or governance costs could be associated with digital? And what was really interesting was that there is a lot of data out there which show you that the environmental footprint of digital infrastructure, and by that I mean the datacentres, or the internet, or 5G, or telecoms, or any communication infrastructure, is rapidly increasing.

There are many governments who are concerned about the amount of electricity, for example, the technology or the digital sector uses, or the amount of electronic waste that is created. I’m sure many of our listeners today have seen so much news flow surrounding the amount of smartphones that are being left or discarded in an unresponsible way. So we do think the environmental costs associated with digital need to be considered by investors.

However, Julien, one of the areas where I think that deserves the most attention is the social costs. Now, this is, you know, at first blush you’re probably thinking what are the social costs associated with digital? If we take a step back and look at all of the latest datapoints, not just from the UN or the World Bank, but also some of the local telecom or technology regulators, there is a big concern regarding what impact digital technology is having on public health. There’s a lot of data which shows, particularly for children, the impact it’s having on childhood obesity or myopia, for example. And even more worryingly is probably the impact it’s having on online safety, and that’s not just children, it’s also every consumer out there in terms of how their data is being used by companies within their technology space.

So, in our view, those environmental or social costs, we think these costs will continue to increase and we think they will pose a material risk to investment portfolios because we do think there is the potential for these costs to potentially outweigh the benefits of digital, if not appropriately managed by society or investors.

Now, I know you’re probably thinking, well, OK, that’s great, Hiral, we’ve thought about some of the costs associated with digital, but what is that catalyst for an investor? And in my view, that catalyst is regulation. We think there is a lot of regulation that’s coming to the fore in the next 12 to 18 months, and we think that there will be a lot more focus by regulators across the US, Europe, and China focusing on things like the governance aspect of big tech or the focus on data privacy, or even a recent focus on cryptocurrencies and algorithms.

And we think that this regulation may force some of these new trends that investors are getting very interested about to slow down. And that puts a lot of pressure on us, as clients or investors, to think about if we have this regulation that is trying to slow down technology, how would this impact some of our trends?

And in our view, the trends that we see most at risk from potential regulation in the future are those that are typically related to consumer-facing technology, so the future of education technology or gaming, but also relating to the use of personal data. And I think, in particular, this relates to the future of digital payments and fintech, as well as predictive healthcare and telehealth.

JL: Great. And maybe last question to finish, are there certain thematic areas or sustainability topics that you believe remain underinvested? Do you think that those actually have struggled to receive enough interest or capital for a specific reason?

HP: I think there are two areas that remain underinvested. The first one is any trends or investment areas relating to social inclusion. I’ve said this for many years now that within the ESG or the sustainability space, there is a lot of focus on the environmental topics but little is done on the social side. And if we take a step back and think about over the last 12 to 24 months and all of the news flow relating to the pandemic, there are so many datapoints which show you that the ongoing impact generational inequalities is having on society, especially when it comes to the basic access to services like education, healthcare, and basic living.

So within that social inclusion umbrella, the one area I would call out is that digitalisation of healthcare. There is a lot of momentum on the private side. There are a lot of new business models that are trying to come up with business models relating to remote patient monitoring, telehealth, or predictive healthcare, for example, and, to their credit, the digital healthcare space funding has remained pretty resilient.

However, the key question is how many breakout companies have we really seen in the digital healthcare space? And that’s where the issue, or the challenge of scale, comes into question. So it’s great that these companies are receiving sufficient public or private funding, but the key challenge to why I think the digitalisation of healthcare remains underinvested is scale.

It’s a tricky area, scale, for the healthcare industry because there are still many public-private partnerships. You do have to get local government buy-in to get some of these business models to scale. And the second issue, beyond just scale and the level of government buy-in, is the consumers. Again, the narrative often portrayed is that consumers are willing to share their data, are willing to receive personalised recommendations, but on the flipside to that, Julien, we’ve got to also think about, well, what if the consumer doesn’t want to share personal data relating to their healthcare? What if someone feels that they will be unfairly treated because they have got a hereditary issue or they have been diagnosed with a disease or an illness?

So I do think healthcare and the digitalisation of healthcare is one that remains underinvested despite the scope. I was listening to another podcast, actually, a few weeks ago, and they were saying that the two sectors that remain the most underinvested, from a digitalisation perspective, remain healthcare and education, despite the potential. So I think there is great potential, but the question of scale won’t be addressed in the next year or so. I think it will be another five to 10 years because it does take time to get the relevant buy-in from governments and public health officials around the world.

Another area that I think, beyond digitalisation of healthcare, is energy storage. Now, I see a lot of interest towards investments relating to renewable energy. Whether it’s wind, solar, tidal, you have a lot of interest in the future of renewable energy given many decarbonisation targets that have been outlined by governments and companies, and, again, the funding towards these areas remains pretty resilient.

However, I do think there is a need to look further down the value chain. So there’s one thing, we can create as much renewable energy as we can, but the question, or the challenge, in my view is how do we store it? And that relates to my idea that energy storage remains an underinvested area. In a roadmap we think about the future of carbon capture and storage, and I think the number one catalyst for this trend, or this area, at the moment is what was mentioned during COP last year.

So, last year, in COP26, there was a big emphasis on energy storage, and many governments and companies formed various task groups or councils trying to promote the scaling and investments required to promote carbon capture and storage, and long-duration energy storage. And beyond just thinking about COP, I do think that you will hear a lot more about energy storage going forwards because it’s extremely topical.

If we think about all of the macro news flow relating to the rise in extreme weather events or the impact of ageing infrastructure relating to the power grid is having on society, you will see many different types of companies across utilities, energy, or even the datacentre industry will have to invest in energy storage, because there’s one thing creating renewable energy storage, but it’s also making sure that you can store it so that you can use it at times where renewable energy is not available.

It is a very tricky area. When I compare energy storage to healthcare, I think definitely healthcare is probably the one where we’re seeing a lot more momentum compared to say energy storage, but I do think the structural infrastructure-related investment opportunities towards energy storage means that this could be an area we could be talking about for the next 20 or 30 years.

JL: Excellent. Thank you so much, Hiral. I’d really encourage our listeners to go and check the report. It’s full of fascinating insight and your approach to thematic investing is clearly unique, so thanks again.

Now back to markets. This week should be relatively quiet as investors gear up for the first-quarter earnings season, which will start a week from now. The main event to watch this week will be the first round of the French presidential election on Sunday, 10th April. Emmanuel Macron is widely expected to remain in power, but first rounds can sometimes throw surprises, and, therefore, it will be important to see what kind of lead he can secure in the first round. Other than that, it should be pretty quiet on the macroeconomic data front.

With that, let me first reiterate our support to everybody who’s impacted by the war in Ukraine but also let me wish you all the best for the trading week ahead. Thank you.