Inflection Points – November 2022

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Entry points and burnt buildings

Editor’s note: Reflection Points is a monthly series that aims to explore the trends, dynamics and opportunities essential for shaping the thematic investment landscape.

Waiting for an entry point is very common refrain. Many investors hear or mumble these words when market valuations seem high and selling sparks their buying interest. Easy to say but hard to do, waiting for an entry point is irrational. The human instinct is to escape from burning buildings, not in them. While buying now may look like hitting a burning building, market conditions may provide a good entry point into topics well below peak valuations with strong fundamentals.

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  • Behavioral economics identifies a number of barriers to successful investing, and understanding them may help investors make better decisions.
  • Based on data from the past 40 years, at some point during an economic downturn, growth stocks typically become defensive.
  • REITs in US data centers, digital infrastructure, lithium batteries, technology and infrastructure development can provide a combination of growth and stability with off-peak valuations, rapid sales expectations and strong profit margins.

Breaking behavioral patterns

Buying low and selling high seems easy, but thousands of years of human evolution are working against investors. Economists such as Adam Smith and John Maynard Keynes recognized the importance of psychology in economics, but with the passage of time the model of perfectly rational individuals became the norm.1 We humans are not entirely rational, and over the past 40 years behavioral economists have shown ways in which people reliably deviate from rational decision-making. Some of them are important for investing in challenging markets.

One important behavioral insight is loss aversion. People become more risk averse after experiencing losses and are more accepting of risk when they see gains.2 This behavior is the opposite of buying low and selling high. Historically, buying the S&P 500 after a 25% drop is a good investment, returning 15% on average over the next year, but investors are tough against acting at the entry point.3

Another view is the tendency to think in fairly nominal terms.4 For example, many people tend to ignore inflation. A 4% return on short-term debt may seem attractive after years of low rates, but that rate is less attractive when inflation is 8%. A real return of -4% appears to be less attractive. The same trend applies to income gains, which may help explain why even though higher wages still can’t keep up with inflation, consumer spending and sentiment remain healthy.

It is difficult to act in ways that conflict with these behavioral patterns. Perhaps the best we can do is learn from historical market activity.

Growth eventually becomes defensive

In each of the past five recessions going back to the mid-1970s, growth indices like the Nasdaq and Russell 1000 Growth have outperformed the broader S&P 500.5 Growth tends to be hit particularly hard early on for the broader stock markets, but as investors’ focus shifts from tighter liquidity to slower growth, sectors of the economy that can grow faster become attractive. When this shift occurs is different. In 1980, the growth-oriented Nasdaq hit bottom compared to the S&P 500 after 61 days of stagnation. In 1981, growth reached its lowest level after 295 days.6

In 2022, growth sell-offs were steeper than those of the broader market. The Russell 1000 growth index shrank from 34-fold to 22-fold, compared to a long-term average of 22-fold.7 By contrast, the forward price-earnings multiplier for the S&P 500 has shrunk from 23 times to 16 times, compared to the long-term average of 18 times.8

While growth topics have generally continued to struggle, many have performed on par with the S&P 500’s -9% return over the recent period.9 From September 14 to October 14, the topics that improved revenue from the previous month and performed as well or better than the broad market included robotics and automation, Internet of things, genomics, seniors, and US infrastructure. The relative success of robotics, automation, and the Internet of Things likely speaks to the continued strength of corporate investment. Genomics and population aging have made headlines with the formation of new cancer treatment coalitions. The infrastructure of the United States remained flexible and defensive.

Tactical Objective Framework: Valuation, Growth and Profitability

In the midst of uncertainty, focusing on growth alone may introduce vulnerabilities, but growth themes that have come under significant price pressure in 2022 may provide compensation due to cheaper valuations. Given that interest rates are significantly higher than the beginning of the year, profitability is now even more important. Companies with higher profitability will have less need to access the capital markets amid higher prices and lower stock values ​​with more resources to invest in for growth.

REIT topics in data centers, digital infrastructure, battery and lithium technology, and US infrastructure development combine high growth, squeezed multiples, and healthy operating margins. Combining these themes may be a successful thematic investment strategy in the coming months (Chart 1).

REITs in Data Centers, Digital Infrastructure, Lithium Technology, Batteries, and US Infrastructure Development Topics - Operating Margin

The valuation of REITs in data centers and digital infrastructure has been compressed significantly this year, but is expected to achieve rapid sales growth of 55% through 2023.10 Unlike the broader REITS sector, these companies are not prone to consumer or economic downturns because they provide important services to businesses. Data center capacity demand tripled in the first half of 2022, and companies are expected to add 20% more capacity.11 With this theme, investors can experience a sequential 12-month operating margin of 23% after a sell-off that drove forward price-to-earnings down 19 times.12

Lithium and battery technology is another topic that appears to be in good shape after the price to forward earnings of its companies plunged 15 times from 39 times in January.13 The demand for batteries is growing with electric vehicle sales growing 43% by 2023.14 The broader US electric vehicle market is expected to grow from 446,000 units in 2021 to nearly 2.3 million by 2030, and suppliers will struggle to keep up with that pace, and are likely to keep prices high.15th The companies have generated operating margins of 9% in the past 12 months and have reduced their leverage to 49% from 68% in 2019.16

The last topic highlighted here may come as a surprise: infrastructure development in the United States. The 2021 “infrastructure trade” may have passed, but the breakup has created a potential buying opportunity. Ratings of US infrastructure companies shrank from 22-fold to 15-fold in 2022, but companies are still expected to increase their line of business by 16% through 2023.17 Their market performance has been resilient a year to date, outperforming the S&P 500 by nearly 7%.18 In the longer term, the infrastructure bill as of 2021 represented only $1.2 trillion of the $2.6 trillion in infrastructure spending over the next 10 years, and private sector investment may be put in place to help fund the shortfall.19 While operating margins were solid at 13% in the subsequent twelve months, the industry fell back on leverage with the debt-to-equity ratio dropping to 79% in 2022 from 92% in 2019.20

inversion point dashboard theme

Features - monthly price change
Attributes - Google Trends Data and Revenue Revisions
Attributes - changes in multiples of price to forward earnings

footnotes

  1. Kammerer, C. F. and Lowenstein, J. (2004). Behavioral Economics: Past, Present, and Future. Advances in behavioral economics. Princeton University Press.
  2. ibid.
  3. Global X analysis with information drawn from: Bloomberg LP (nd) [Data set]. Retrieved October 17, 2022.
  4. Kammerer, C. F. and Lowenstein, J. (2004). Behavioral Economics: Past, Present, and Future. Advances in behavioral economics. Princeton University Press.
  5. Global X analysis with information drawn from: Bloomberg LP (nd) [Data set]. Retrieved October 17, 2022.
  6. ibid.
  7. ibid.
  8. ibid.
  9. ibid.
  10. ibid.
  11. (2022, August 8). Record demand fuels H1 2022 A breakthrough in data center development in North America. https://www.cbre.com/insights/briefs/record-demand-fuels-h1-2022-surge-in-north-american-data-center-development#:~:text=The%20North%20American%20data %20 Position A %20 Impression %20 %20 Organization %20 Demand.
  12. Bloomberg, L.P. (Second). [Data set]. Data as of September 19, 2022 and retrieved.
  13. ibid.
  14. ibid.
  15. International Energy Agency. (2021). Global Electric Vehicle Outlook 2021: Accelerating ambitions despite the pandemic. Trends and Developments in Electric Vehicle Markets – Global EV Outlook 2021 – Analysis – International Energy Agency
  16. Bloomberg, L.P. (Second). [Data set]. Data as of September 19, 2022 and retrieved.
  17. ibid.
  18. ibid.
  19. American Society of Civil Engineers. (March 2021) ASCE Infrastructure Report Card awards US C-score, says trillion investment gap, bold action needed. ASCE Infrastructure Report Card Gives US a C- Score, Says Trillion Investment Gap, Bold Action Needed
  20. Bloomberg, L.P. (Second). [Data set]. Data as of September 19, 2022 and retrieved.

Glossary of terms

Topic dashboard – reference index for each theme:

  • Blockchain – Solactive Blockchain Indicator
  • Disruptive Substances – Single Disruptive Substances Index
  • Lithium Technology and Battery – Solactive Global Lithium Indicator.
  • FinTech – Indxx Global FinTech Thematic Index
  • Cloud Computing – Indxx Global Cloud Computing Index
  • Robotics and Artificial Intelligence – Indxx Global Index of Robotics and Artificial Intelligence
  • China’s Biotechnology Innovation – China’s Biotechnology Innovation Index
  • Artificial Intelligence – Indxx Index for Artificial Intelligence and Big Data
  • Cyber ​​Security – Indxx Cyber ​​Security Index
  • The Millennial Consumer – Indxx Millennials . Index
  • E-Commerce – Solactive E-Commerce Indicator
  • Genomics and Biotechnology – The Solactive Genomic Index
  • Data Center REITs and Digital Infrastructure – Solactive Data Center REITs and Digital Infrastructure Index
  • Social Media – Total Revenue Index for Social Media Solactive
  • Solar Energy – Solactive Solar Energy Index
  • Autonomous and Electric Vehicles – Autonomous and Electric Vehicles Index
  • Education – Indxx Global Education Thematic Index
  • Telemedicine and Digital Health – Solactive Telemedicine and Digital Health Index
  • Hydrogen – Global Single Hydrogen Indicator
  • Internet of Things – Indxx Global Internet of Things Thematic Index
  • Internet in Emerging Markets – Nasdaq CTA Internet and Emerging Markets Net Total Net Return Index for Online and E-Commerce
  • US Infrastructure Development – US Infrastructure Development Index Indxx
  • Cannabis – Catalog of cannabis
  • CleanTech – Indxx Global CleanTech Index
  • AgTech and Food Innovation – Solactive AgTech and Food Innovation Indicator
  • Health and Wellness – Indxx Global Health and Wellness Index
  • Renewable Energy Producers – Indxx Renewable Energy Producers Index
  • Population Aging – Indxx Population Aging
  • Metaverse – Global X Metaverse Indicator
  • Clean Water – Global Clean Water Industry Index Solactive
  • Wind Energy – Single Wind Energy Index
  • Video Games and Esports – Solactive Index for Video Games and Esports
  • Green Buildings – Solactive Green Building Index

Information provided by Global X Management Company LLC.

Investing involves risks, including the potential for loss of capital. Diversification neither guarantees profit nor guarantees loss.

This material represents an assessment of the market environment at a specific point in time and is not intended to be a prediction of future events or a guarantee of future results. This information is not intended to be an individual or personal investment or tax advice and should not be used for commercial purposes. Please consult a financial advisor or tax professional for more information regarding your investment and/or tax situation.

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Editor’s note: This article’s bulleted summary was selected by searching for alpha editors.

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