While the market processes various macro concerns, we believe accelerating innovation is creating growth opportunities.

Key Takeaways

  • Current concerns around the COVID Delta variant, rising inflation and variable economic data are driving the potential for volatility; however, we remain constructive on the prospects for growth.
  • We believe that growth opportunities exist in areas that have seen less impact to date from digital disruption and where the market underappreciates the potential duration of innovation.
  • As markets fluctuate in the short-term, we expect companies driving long-term growth to focus on things that are in their control ‒ innovating constantly, strengthening customer loyalty and investing capital intelligently.

We have written previously that as the COVID economic recovery progresses, markets will likely remain locked in a tug-of-war between interest rates and valuations as investors assess the recovery and an appropriate 'risk-free rate'. While the market may fluctuate in the short-term, though, we believe that long-term growth opportunities exist in areas that have seen less impact to date from digital disruption and where the market underappreciates the potential duration of innovation.

The next phase of recovery

As we move through the current period of recovery, the Delta variant has raised fears of renewed social restrictions and the likelihood for the COVID virus to become endemic. At the same time, supply chain bottlenecks and raw material and labor shortages have stoked inflation concerns. While real interest rates globally have been pinned near zero for a considerable amount of time, we are now entering a period where economies are once again beginning to expand. These macro factors may portend stormier weather ahead from an interest rate and economic data standpoint; however, despite the potential for volatility, we remain optimistic about the prospects for growth.

From a macro perspective, consumers eager to re-engage with the physical economy have released substantial pent-up demand, and GDP growth has accelerated significantly as the COVID vaccination effort has steadily progressed. Powerful fiscal and monetary stimulus, strong capital markets performance and a robust housing market have likewise positioned both individuals and corporations to reinforce an already widening economic recovery. As labor supply remains short in the US, we expect higher wages than we have seen over the previous decade, which in general should be supportive of consumers and, thus, a healthy economy. We also believe the deglobalization process ‒ which has been hastened by the pandemic ‒ will continue as critical links in the global supply chain are moved back to the US, encouraging domestic job growth.

As we witnessed at the end of 2020 and earlier in 2021, we expect cyclical, more value-oriented stocks’ earnings to grow faster in 2021, a reversal of the theme that saw the digital economy continue to thrive while the physical economy stalled amid the pandemic. Something that should be watched closely, though, is the fact that many cyclical stocks are benefitting now from comparisons to results from last year, when their businesses collapsed. At the same time, many of the growth-oriented, technology-focused firms that profited directly from the COVID environment will face more difficult comparisons throughout 2021.

The ongoing path of digital disruption

So, while more cyclical, value-oriented stocks may see periods of strength throughout the recovery, we believe that in the long term, innovation will be the primary driver of durable growth. For one, we think the pace of innovation has never been faster across a number of sectors, creating significant opportunities to invest in disruptive companies. In general, we believe that the market does not fully appreciate the potential duration of this innovation. Thus, investors with a long-term time horizon may be able to capitalize on innovative companies’ ability to compound free cash flow at a rate faster than expectations. And while the threat of rising inflation exists, we believe that equities with free cash flow yields higher than other asset class yields, combined with the potential for significant free cash flow growth, remain attractive on a relative basis.

Another advantage inherent in a portfolio of companies that maintain significant competitive moats is pricing power.  We believe companies with pricing power, and a generally favorable margin structure should be able to weather effects of inflation better than the market in general.

We also believe that growth opportunities exist in industries such as healthcare that have been relatively untouched by digital disruption. As we saw across many other industries, the onset of COVID accelerated the adoption of technology in healthcare. One of the enabling technologies that proliferated during COVID was telemedicine, allowing patients to meet remotely with their care providers. Moreover, specialized apps and sensors can now measure vital health information such as breathing, heartbeat, physical activity, sleep patterns and blood glucose levels, relaying that data to healthcare providers and patients, allowing for greater communication and more precise treatments. Areas of healthcare that have traditionally been more 'analog' in nature are now leveraging technology to make the system more efficient, provide better patient outcomes and alternative ways for individuals to access the healthcare system.

A continued focus on growth

As the pace of economic growth has quickened and the potential risk of higher inflation has arisen, we continue to believe in the importance of identifying companies with defensible competitive advantages. Companies with pricing power, improving unit economics and the ability to grow market share while bringing new innovations to the market are typically less exposed to the commoditization of their products and services. And while interest rates, macroeconomic results or news headlines may be the 'rain' that temporarily knocks quality companies 'down the waterspout', we believe it is their growth ‒ in free cash flow, earnings, and continuous innovation ‒ that allows them to keep advancing.