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The events of the past year have accelerated the transformation of energy infrastructure and the digitization of the workplace. Olga Bitel, Partner, Global Equity Strategist, and Hugo Scott-Gall, Partner, Portfolio Manager, Co-Director of Research, Global Equity Team, look back and ahead to consider the investment opportunities beyond the headlines.
Hugo Scott-Gall: Hello, Olga. It’s nice to be walking in the heat. We’re coming off the hottest day ever in the United Kingdom. Records always put you in a reflective mood, so I thought on this walk we could reflect on what a year it has been. It feels like a lot has happened. I want to ask you, which of these changes will we consider important five years from now?
Olga Bitel: Wow, that’s a loaded question. Well, there are the things we’ve already observed. This time last year, inflation was 2%, 3%. It wasn’t on anybody’s radar. Today, we’re pushing up against 10%. Last year, in most developed economies, policy rates were at or below zero, and every central banker was talking about being incredibly patient. Today, everybody’s falling over themselves trying to sound as hawkish as possible.
What has changed is that we’ve now got very strong labor markets and the beginnings of what looks like a very promising investment cycle.
More quietly, away from the daily headlines, Europe agreed on a multi-year – arguably multi-decade – investment fund for things like energy transformation and the digitization of the economy. Interestingly, Italy is one of the countries that has done noticeably better coming out of the COVID crisis, as has France. In Italy, though, we’ve now had a resignation of the government that was largely responsible for making sure the country would have the investments necessary to carry it forward.
In five years, will we look back on this summer and say that when the nativists politicking in Italy decided it was an opportune moment to take down Draghi’s government, that was when Italy’s post-COVID growth trajectory changed?
Alternatively, will we look back and say the crisis reenergized our policymaking apparatus in the developed economies to move in a more coordinated fashion, such that we can address investments to make sure that 40-degree [104-Fahrenheit] scorchers in London are not an annual event?
There’s an opportunity in every crisis. To be fair, it doesn’t feel like we’re in a crisis – we are all doing better today than, arguably, we have been in a long time. But it does feel as though we’re in a pivotal moment where we can take a massive step forward, in terms of our growth trajectories, in terms of investment, in terms of electrifying our economies, in terms of bringing more people into the labor force. That’s the biggest opportunity to emerge in the past year.
Five years from now, I don’t think we’ll be talking about the crazy old inflation. I don’t think we’ll be particularly worried about the central bankers being behind the curve or in front of the curve or next to the curve. But I do think that the investment regime that we’ve been putting in place over the past year may have profound effects on our economic growth trajectories, and on geopolitics as well.
Hugo: Can you talk a bit more about the energy side of the investment regime? Right now, the world is experiencing an energy supply shock, and Europe is arguably most disadvantaged by this change. Is it within the Europeans’ grasp to achieve something of a permanent solution? Without resorting to cliché, is this the last energy crisis?
Olga: I like your way of putting it. I’m not sure if it is the last energy crisis. We’ve had a major geopolitical event in Europe with the Russian invasion of Ukraine, which is basically open war with no end date. The sanctions that have accompanied the Western response to this aggression have challenged European energy imports.
Europe – along with Japan, China, and most other developed or rapidly developing economies – is energy-dependent, in sharp contrast to the United States. Europe is reliant on external sources for its energy needs, whether it’s oil or gas or some other form of fossil fuel energy. And so, curtailing Russian gas supplies in the short term is likely to be very disruptive for economic activity.
There is no common energy market in Europe today. Most importantly, there is no infrastructure that allows interoperability within Europe. You can’t easily divert extra energy via pipelines or grid from Spain to, say, Germany or Austria, or really anywhere along the Rhine corridor.
Building out that infrastructure is technically quite feasible. China built a high-voltage grid in a matter of years. Europe can certainly do the same: there is institutional capacity, there is bureaucratic capacity, there is technological capacity. And certainly, capital markets can be called upon to organize the financing to bring about something like this. What is needed is a common framework, a broad agreement on the need for this policy to move forward and then a swift execution.
Accomplishing all of this in five years is aggressive. But as we know, Europe integrates in crises. European common energy policy has been in conference-room discussions for decades. This crisis might prove to be acute enough to necessitate a rapid response.
On the demand side, we now also have the commercialization of the technology in place for a wholesale electrification of our transport systems, not least in Europe. There are obvious challenges of what to do with legacy assets, but I think that’s a technical problem that can be solved. I think the labor challenges that go along with it can also be solved. There could be pensions and retraining schemes along the lines of what Sweden managed to achieve in its terrible crises in the early and mid-1990s.
So there are definitely blueprints for navigating this, and for really creating a massive opportunity out of the crisis. If Europe were to eventually become partially energy-independent, where you can mitigate the increased costs of having to import liquefied natural gas, rather than get gas directly from Russian pipelines, and European competitiveness, at least on energy costs, was roughly in line with U.S. standards today, that would meaningfully accelerate European growth in a number of areas. That shift, that opportunity, could be more or less permanent.
Hugo: That’s very interesting. One of the other things I’m interested in is that we’ve sort of woken up from the pandemic into a different-feeling economy. Part of that, I think, is just the grinding of the gears where demand and supply are not in sync.
In addition, you could make the argument before that we were in something of a technology-led, disruptive economy that was leading to a winner-takes-all phenomenon, in which a lot of industries were getting very concentrated, particularly in the United States.
If that assertion is correct, do you see anything that makes the next decade look different – that we might see a shift in ownership or a shift in how much the median player owns? Or do you think we’re still in the sort of concentrated, winner-take-all type of economy?
Olga: That’s a trillion-dollar question, literally. The short answer is, I don’t know. But here are the forces I see beginning to play out. As to the concentration of profits that you’re talking about, there are some business models that are more obvious than others. Digital advertising was one means of amassing this massive concentration of profits. It is difficult to argue that the growth of that profit pool in the next decade will be as substantial as it was in the past decade and a half – largely because the base is now much bigger, and secondarily, because there is a non-negligible pushback against it.
Europe has tried to pry open these markets with the recently agreed Digital Markets Act, DMA. China, as we know, has moved aggressively against its platforms grabbing too much economic and potentially even political power. While that may produce negative headlines, it could be positive from the lenses of economic development and investment opportunities, something our investability framework deals with explicitly.
At the same time, we’re seeing the digitization of the economy and COVID-induced remote work – and I don’t just mean Zoom meetings. Entire back-office operations of multibillion-dollar companies have resisted a move to the cloud for a long time, and the crisis has forced their hand. We’ve seen a movement of entire finance departments of Fortune 100 global companies to the cloud in one year, having resisted that choice for 20 years.
That’s a tremendous shift in the way that data is compiled, in the way that decisions can be made, in the distributive nature of the workforce that is now enabled by this shift. You don’t have to have finance professionals or operational groups sit in headquarters, for example. They can live anywhere. And if that’s true, why do you need to petition the U.S. State Department for immigrant visas to bring more engineers or financiers into your companies? You can just employ these people wherever they’re located – at a fraction of the price, I might add. So the profitability of old-economy companies, for lack of a better term, has probably improved in ways that we don’t yet appreciate, even as the concentration of profits, in many cases, may have largely run its course.
The second point is that this investment bid that we just started talking about, especially as it relates to energy, is potentially broader. If the diagnosis that we’ve massively underinvested in our economies is correct – and that appears to have been the message that the policymakers adopted – then mobilizing and sustaining significantly stronger investment in the next decade is likely to pave the way for a broader distribution of profit pools and to begin to move the needle toward some equilibrium. It’s too early to say where and how. But that is definitely something that we should be thinking about.
Hugo: This seems like the beginning of an investment thesis for the next decade. We said we were looking backwards, and we’ve ended up looking forward.
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.
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