New Technologies Creating an Era of Disruption

Social media, renewables, biologics, bots to robotics. The age of innovation is upon us, and it is bringing a sea change to societies, sectors, and the global economy. Here, the Third Industrial Revolution, transition to a low carbon economy, and disruption in telemedia are topics explored by investment professionals from across Natixis Global Asset Management.
Chris Wallis, CFA®

CEO and Portfolio Manager Vaughan Nelson Investment Management

The Third Industrial Revolution is under way, and it is rapidly affecting sectors and industries across the global economy. Unlike the prior two industrial revolutions – which were centred on organising labour and capital, and then the mechanisation of labor with the creation of the assembly line – this one is all about shared resources. What I mean by shared resources is: the Uber effect, the Amazon effect, the cloud-computing effect.

All of these forces are very structurally deflationary (a persistent decrease in the level of consumer prices). This is not necessarily a bad thing as it is not corrosive deflation. In fact, it could be very positive in a lot of ways. The shared-resources phenomenon has the potential to free up capacity of both human and capital resources, which then can be reallocated to pursue other endeavours.

That said, we are going to see disruptive effects across the economy. For example, the Amazon effect will continue to challenge retail to rethink business models. Healthcare is another place where significant change is coming. Already, real innovations in biologics and genomics have the potential to drive down healthcare costs. This could be incredibly deflationary and I suspect we could have huge productivity gains in those areas. We should also see it in financial services. For example, bank branches are no longer as necessary as they used to be. Overall, I suspect we will see reduced capital cost in large parts of our economy.

But what is good for one may not be good for others. When you look at the markets in general, they usually don’t reflect the economy as a whole. Financial markets are still very much geared to just what is publicly traded, and the allocations across sectors don’t reflect the economy. Therefore, an economy can be fine, but it can present challenges for a market.

Next five years may look different

As the economy is in the process of hitting a reset button, I believe the next five years may look incredibly different for the financial markets. This is very similar to what you would expect from a market correction. There are two ways the markets might correct themselves – either through price or time. If they correct by price, price has to decline to clear the market. If they correct through time, you can maintain your price level but it goes sideways for a while until fundamentals catch up.

If the next monetary and fiscal policy choices are correct, then we can probably reset through time. We would be able to slowly rebuild some inflationary pressures in the system. The way that might manifest itself in the markets is you could see declines in margins but expansion of P/E ratios and long-term growth rates. Then the level of asset value existing in the economy could be maintained for a while. In this scenario, there probably wouldn’t be significant, abrupt changes in people’s consumption habits and savings habits. Therefore, this would be a fairly benign process – not great, but not a crisis.

Overall, I believe investors need to realise that returns from an index such as the S&P 500® will most likely be considerably less than they have witnessed during the past five years. Individual security selection will become more and more critical.

Ladislas Smia

Deputy Head of Responsible Investment Research Mirova

The transition to a low carbon economy is now in motion. The necessary technologies have left the laboratory and, in many cases, entered the industrial phase. For long-term investors, this transformation away from traditional fossil energy (oil, coal, gas) presents interesting opportunities today.

Heightened awareness regarding climate change and the agreement accepted by 195 countries at the Paris COP21 Climate Conference in December to limit global warming to below 2° C should only help to accelerate this transition to a low carbon economy. The Paris agreement is the first to involve all world economies in the fight against climate change. Beyond the pledges made by the governments, COP21 also aimed to highlight solutions that are backed by the private sector. In fact, numerous companies worked together during the two-week conference to launch initiatives across a wide range of sectors.

For example, many players in the financial sector announced that they would divest from the most polluting energies, increase investments in clean technologies, stimulate financial innovation, such as green bonds, and measure carbon footprints. To do so, it appears the financial sector now has to understand how companies adapt to the current transition to a low carbon economy and adapt their investment strategies to seize these new opportunities.

How companies adapt to the current transition

The world’s current energy model is founded on decades of investment in fossil energy. The weight of this heritage naturally implies significant inertia on every level. Nevertheless, the broader picture offers several encouraging signs. Driven by regulatory developments, companies need to evolve.

  • The energy spectrum has been radically transformed, in particular, with an increase in renewables, which have forced major electricity companies to revise their models.
  • The transportation sector is witnessing profound changes with alternative mobility solutions and significant improvements in the energy efficiency of current technologies.
  • The building industry, where inertia is likely the strongest due to its decentralisation, is also facing a cultural change, with greater expectations in terms of insulation, smart monitoring of consumption and alternative heating (heat pumps) and lighting (LED) solutions.
  • Major industrial players are pursuing a strategy of developing eco-efficient solutions in line with the cost-reduction expectations of the sector.

Among all these transformations, two sectors face the emergence of disruptive solutions: the energy sector, as decreasing costs have led solar and wind energy to compete with traditional energy; and the transportation sector, where the development of electric vehicles is a potential game changer.

Solar and wind will soon be cost competitive

Various forms of regulatory support across most regions of the globe have allowed for the emergence of an industry that is now in a position to propose increasingly competitive technology compared with traditional production methods. By way of illustration, the cost of solar power has dropped by more than 75% over ten years. This downward trend should continue, driven by economies of scale and technological improvements. Also, contrary to other types of energy, solar power draws on an almost unlimited source of energy, giving this technology an advantage over the very long term.

The trend is already present for wind power, which has seen an average growth of over 20% per year over the last ten years. Europe, especially Germany, Spain, the UK and Denmark have been pioneers in developing wind power. Now we have reached a new level of maturity with the United States and China investing in the technology since 2005, while China became the world’s biggest market in terms of installed capacity in 2009.

Despite the growing importance of alternative energies, we should remember that fossil fuels still account for almost 80% of the global energy mix. Yet, this energy mix is incompatible with keeping the rise in temperatures below the 2° C threshold to avoid the most serious consequences of climate change. In the transport sector, which makes up around 15% of global greenhouse gas emissions, a number of players have committed themselves to supporting the emergence of low carbon mobility. Players such as Tesla and Renault-Nissan, along with the United Nations Environment Programme (UNEP), the International Energy Agency (IEA) and other representatives of civil society, launched the Paris Declaration on Electro- Mobility and Climate Change & Call to Action. Its signatories are committed to making the greatest efforts possible in raising the share of electric vehicles to 20% of automobiles in circulation by 2030.

Overall, these innovations are favouring the emergence of increasingly competitive economic models as compared to traditional fossil-fuel-driven solutions. The finance sector has to embrace the necessity of adapting its investment strategies to be compliant with the energy transition.

Editor’s Note: Ladislas Smia’s commentary is primarily from Mirova’s research report: What Technologies Can Build a Low Carbon Economy. It was co-written by Emmanuelle Ostiari, SRI Analyst at Mirova.

Janet Sung, CFA®

Credit Research Senior Analyst, Loomis, Sayles & Company

Frequently disruptive, creative change will always be a key factor to reckon with in the telemedia industry, as long as telemedia remains as vital as it is today. It’s part of the combined cable, telecom and media sectors’ dynamism – its DNA. That said, providing information services and entertainment to consumers around the world has never faced more challenging industry conditions, as dramatic shifts in technology, competition, consumer behaviour and regulation transform the landscape. Below is a list of potential disruptions in the making for the telemedia universe. It’s a long, fluid list that can change almost with the swiftness of clicking to a new channel. That’s part of telemedia’s current reality show.

  • Apple TV. Netflix, Hulu, YouTube, Sling by DISH, HBO Now, CBS All-Access, and Amazon Prime are just a few online video options that have already made major inroads into the linear video ecosystem. But the most anticipated formidable entrant, an Apple live TV service, has yet to launch. Apple’s brand power and uncanny ability to create the best user interface presents the biggest threat to the linear TV industry. However, this service has been repeatedly delayed by what we believe is greater difficulty in acquiring content. The quest for content could eventually lead the tech giant to outright buy a large media production company such as Time Warner Inc. or a video streaming service such as Netflix, per recent press reports.
  • Google has made splashy headlines on its entry into residential fiber, online video through YouTube, and wireless on Wi-Fi. Thus far, the impact on the telecom, cable and media industries has been limited, but the tech giant’s actions should keep existing industry players on their toes. For example, AT&T has accelerated fiber roll-out in cities offering Google Fiber. Thus far, Google has only rolled out fiber in selected areas in Kansas City, Austin, Provo, Nashville and Atlanta, but according to Google, has plans to expand in bigger cities including Chicago and Los Angeles.
  • 5G, the next wireless evolution, could potentially match cable in speed. Verizon has already begun field tests and expects some level of commercial deployment in 2017. Tests so far show speeds up to 3.77 gigabits per second, or more than 300 times faster than a typical 4G LTE connection and 3-4X faster than Google Fiber. AT&T plans to begin 5G trials by the end of the year and aims for > 5 gigabits per second speeds. So wireless can be a more credible contender to cable for video downloading in the future.
  • Wireless over Wi-Fi. There are currently about 50 million Wi-Fi hotspots across the nation, and cable companies and municipalities plan to add many more. Thus far, Wi-Fi-first or Wi-Fi-only services have not made much of a dent on cellular provider revenues, but it is conceivable that with handoff technology advancements, new spectrum allocation and network contracts with cellular carriers, wireless on Wi-Fi could pose a more serious threat to the wireless telecom industry. For example, Comcast has activated its MVNO agreement with Verizon, which will give the cable giant access to Verizon’s cellular network as a back-up to its own Wi-Fi network. However, we believe the cable industry is more interested in providing mobile video distribution to its subscriber base rather than acting as a competitor in the already crowded wireless industry.

Survival of the fittest

While it is naïve to believe the ecosystem will be preserved in its current form over the long run, we do not profess to know precisely how the ecosystem will evolve or the shape it will ultimately take. As such, we favour companies most adaptable to a shifting ecosystem and where our conviction in maintaining solid (albeit likely lower) profitability remains.

To elaborate, we believe companies with lower advertising exposure, content less amenable to time-shifted viewing (e.g., sports and news), properties that work in a direct-to-consumer platform, meaningful international growth prospects, and lower event risk potential are those best positioned to withstand an evolving and uncertain ecosystem. In other words, picking the right company within the media sector garners considerable importance. Editor’s Note: Commentary is taken from the research report Telemedia’s New Reality Show: Cord-Cutting, Shaving and Cord- Nevers which was co-authored by Ryan Yackel, Credit Research Senior Analyst at Loomis, Sayles & Company.

Editor's Note: Commentary is taken from the research report Telemedia's New Reality Show: Cord-Cutting, Shaving and Cord-Nevers which was co-authored by Ryan Yackel, Credit Research Senior Analyst at Loomis, Sayles & Company.

Published in September 2016

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This communication is for information only and is intended for investment service providers or other Professional Clients.
The analyses and opinions referenced herein represent the subjective views of the author as referenced unless stated otherwise and are subject to change.
There can be no assurance that developments will transpire as may be forecasted in this material.

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