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The events of the past year have accelerated the transformation of energy infrastructure and the digitalization of the workplace. Olga Bitel, Partner, Global Equity Strategist, and Hugo Scott-Gall, Partner, Portfolio Manager, Co-Head of Research, Global Equity Team, look back and forth to consider investment opportunities beyond header rows.
Hugo Scott Gall: Hello Olga. It’s nice to walk in the heat. We are coming off of the hottest day ever in the UK. Records always put you in a reflective mood, so I thought on this walk we could reflect on what a year has been like. A lot of things happened. I want to ask you which of these changes will we consider important in five years?
Olga Bitel: Wow, that’s a loaded question. Well, there are the things that we have already observed. At this time last year, inflation was 2%, 3%. It wasn’t on anyone’s radar. Today, we are pushing 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, everyone crumbles trying to sound as belligerent as possible.
What has changed is that we now have very strong labor markets and the start of what looks to be a very promising investment cycle.
More quietly, away from the daily headlines, Europe has agreed on a multi-year – arguably multi-decade – investment fund for things like energy transformation and the digitalisation of the economy. Interestingly, Italy is one of the countries that has come out of the COVID crisis noticeably better, as has France. In Italy, however, we have now had a resignation from the government which was largely responsible for ensuring that the country would have the investment needed to move it forward.
Five years from now, will we look back on that summer and say that when the political nativists in Italy decided the time was right to overthrow Draghi’s government, that’s when the post- Italy’s COVID has changed?
If not, will we look back and say that the crisis has reinvigorated our policy-making apparatus in developed economies to move in a more coordinated way, so that we can approach investments to ensure that 40 degrees [104-Fahrenheit] scorchers in London aren’t an annual event?
There is an opportunity in every crisis. To be fair, we don’t feel like we’re in a slump – we’re all doing better today than, arguably, we’ve been in a long time. But it feels like we’re at a pivotal moment where we can take a big step forward, in terms of growth trajectories, in terms of investment, in terms of electrifying our economies, in terms of hiring more people in the labor market Force. This is the biggest opportunity that has presented itself in the last 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 central bankers being behind the curve or ahead of the curve or beside the curve. But I think the investment regime we’ve put in place over the past year can have profound effects on our economic growth trajectories, as well as geopolitics.
Hugo: Can you tell us a bit more about the energy aspect of the investment regime? The world is currently experiencing an energy supply shock, and Europe is arguably the most disadvantaged by this change. Is it within reach for Europeans to achieve some sort of permanent solution? Without falling into the cliché, is this the last energy crisis?
Olga: I like the way you say it. I don’t know if this is the last energy crisis. We had a major geopolitical event in Europe with the Russian invasion of Ukraine, which is essentially open warfare with no end date. The sanctions that accompanied the Western response to this aggression put European energy imports to the test.
Europe – along with Japan, China and most other developed or rapidly developing economies – is energy dependent, unlike the United States. Europe depends on external sources for its energy needs, be it oil, gas or some other form of fossil energy. Thus, the reduction in Russian gas supply in the short term is likely to be very disruptive for economic activity.
There is no common energy market in Europe today. More importantly, there is no infrastructure for interoperability within Europe. You can’t easily divert additional power via pipelines or grid from Spain to, say, Germany or Austria, or really anywhere along the Rhine corridor.
Building this infrastructure is technically quite feasible. China has built a high-voltage grid in a few 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 arrange the financing necessary to achieve something like this. What is needed is a common framework, broad agreement on the need to move this policy forward, and then rapid execution.
Accomplishing all of this in five years is aggressive. But we know that Europe is integrated into crises. The common European energy policy has been discussed in conference rooms for decades. This crisis could prove acute enough to require a rapid response.
On the demand side, we now also have the commercialization of the technology in place for wholesale electrification of our transportation systems, especially in Europe. There are obvious challenges in knowing what to do with legacy assets, but I think it’s a technical problem that can be solved. I think the labor issues that come with it can be solved as well. There could be pension and retraining schemes on the model of what Sweden managed to achieve during its terrible crises of the early and mid-1990s.
So there are certainly plans to navigate this area and to really create a huge opportunity out of the crisis. If Europe were to eventually become partially energy independent, where one can mitigate the increased costs of importing liquefied natural gas, rather than getting gas directly from Russian gas pipelines, and if European competitiveness , at least in terms of energy costs, roughly matched US standards today, which would significantly accelerate European growth in a number of areas. This change, this opportunity, could be more or less permanent.
Hugo: It’s very interesting. One of the other things that interests me is that we kind of woke up from the pandemic to an economy with different feelings. Part of it I think is just gear grinding where demand and supply are out of sync.
Also, you could argue before that we were in a sort of disruptive technology-driven economy that was leading to a winner-takes-all phenomenon, in which many industries were becoming very concentrated, especially in the United States. .
If that statement is correct, do you see anything that makes the next decade different – that we might see a change in ownership or a change in the amount of median player ownership? Or do you think we’re still in the winner-takes-all kind of concentrated economy?
Olga: It’s a trillion dollar question, literally. The short answer is, I don’t know. But here are the forces that I see beginning to play. As for the concentration of profits that you are talking about, there are business models that are more obvious than others. Digital advertising was one of the ways to amass this massive concentration of profits. It is difficult to say that the growth of this profit pool over the next decade will be as significant as it has been over the past fifteen years – largely because the base is now much larger and , secondly, because there is a not insignificant part pushing against it.
Europe has attempted to open up these markets with the recently passed Digital Markets Act, DMA. China, as we know, has acted aggressively against its platforms grabbing too much economic and potentially even political power. While this may produce negative headlines, it could be positive from the perspective of economic development and investment opportunities, which our investability framework explicitly addresses.
At the same time, we are seeing the digitalization of the economy and COVID-induced remote working – and I’m not just talking about Zoom meetings. Entire back-office operations of multibillion-dollar companies have long resisted the move to the cloud, and the crisis has forced their hand. We have seen a movement of entire financial services from Fortune 100 global companies to the cloud in one year, having resisted the choice for 20 years.
It’s a huge change in the way data is compiled, in the way decisions can be made, in the distributive nature of labor that is now enabled by this change. You don’t need to have finance professionals or operational groups at head office, for example. They can live anywhere. And if that’s true, why do you need to apply to the US State Department for immigrant visas to attract more engineers or financiers to your companies? You can simply employ these people wherever they are – at a fraction of the cost, I might add. So the profitability of old-economy firms, for lack of a better term, has probably improved in ways we don’t yet appreciate, even though the concentration of profits, in many cases, may have be largely run its course.
The second point is that this investment offer that we have just started talking about, particularly with regard to energy, is potentially broader. If the diagnosis that we have massively underinvested in our economies is correct – and this seems to have been the message adopted by policy makers – then mobilizing and sustaining significantly higher investment over the next decade is likely to open the door way to a wider distribution of profit pools and to start moving the needle towards some balance. It is too early to say where and how. But it’s definitely something we should think about.
Hugo: This seems like the start of an investment thesis for the next decade. We said we were looking back, and we ended up looking forward.
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Editor’s note: The summary bullet points for this article were chosen by the Seeking Alpha editors.
