Long-term Trends

Invest in the Future, Not in the Past

Many investment strategies are based on the implicit assumption that the future will mirror the past. Quantitative traders evaluate their strategies by back-testing against historical data, with the implicit assumption that future performance is likely to mirror the past. This often means that new opportunities are missed and old investment favorites are held long after their time has passed.

Technology stocks were shunned by many conservative investors, most notably Warren Buffett, for decades as there was little history to evaluate them by. Past market dominance is often disrupted by new technologies:

  • traditional news media are losing advertising revenue to online competitors;
  • high street retailers are likewise losing ground to online competitors; and
  • the oil and gas industry faces a long-term threat from renewable energy.

Investment strategy should be based on the future as well as the past. Past history may provide a base for projecting future performance but it is no guarantee. While we cannot foresee the future, evaluation of existing structural trends will help us to avoid industries under threat of disruption and take advantage of new opportunities as they unfold.

Structural Trends

Structural (or secular) trends are long-term trends that normally span several decades; sometimes even centuries.

Ageing Populations in Developed Countries

Populations in most developed countries are ageing due to low birth rates and the baby boom after World War II. This is best illustrated by the growing percentages of population aged 65 and over.

Ageing Populations

China is experiencing a similar ageing population as a result of its one-child policy.

Ageing populations are likely to increase demand for health services, retirement accommodation, and investment services.

Growing Populations in Undeveloped Countries

The number one dynamic over the last century has been the exponential rise in global population. It took 123 years for the world population to grow from 1 to 2 billion (in 1927) and only 12 years to grow from 5 to 6 billion (in 1999). Growth, however, is now slowing and we are predicted to rise from the current 7 billion to a peak of 9 billion in the 2050s.

Population in South Asia and Sub-Saharan Africa

This is from The End of Population Growth – Sanjeev Sanyal – Project Syndicate:

What demographers call the Total Fertility Rate is the average number of live births per woman over her lifetime. In the long run, a population is said to be stable if the TFR is at the replacement rate, which is a little above 2.3 for the world as a whole, and somewhat lower, at 2.1, for developed countries, reflecting their lower infant-mortality rates.

The TFR for most developed countries now stands well below replacement levels. The OECD average is at around 1.74, but some countries, including Germany and Japan, produce less than 1.4 children per woman. However, the biggest TFR declines in recent years have been in developing countries. The TFR in China and India was 6.1 and 5.9, respectively, in 1950. It now stands at 1.8 in China, owing to the authorities’ aggressive one-child policy, while rapid urbanization and changing social attitudes have brought down India’s TFR to 2.6.

…. it is likely that world population will peak at nine billion in the 2050’s, a half-century sooner than generally anticipated….

We are likely to face increasing scarcity of food and water. Advances in technology have improved crop yields, but increased meat consumption in China and other Asian economies will reduce overall output. The area of land required to produce an equivalent amount of edible protein from livestock is 4 to 5 times higher compared to traditional grains and legumes, and up to 10 times higher for beef. Diversion of land use for ethanol production may also restrict food output.

Global warming, whether man-made or a natural cycle, may also contribute to declining food production — through droughts, floods and depleted fish stocks.

Global Warming

Global Land-Sea Temperature

Global Land-Ocean Temperature Index
Data source: NASA’s Goddard Institute for Space Studies (GISS).

Whether man-made or a natural event, climate change is likely to present challenges to water resources and food production – both agriculture and fisheries. Global warming is also driving a shift away from fossil fuels towards renewable energy.

Decline of coal

Coal output is expected to remain steady over the next 5 years but then decline as the shift to LNG and renewable energy grows. From the Sydney Morning Herald:

Worldwide coal consumption dropped in 2014 for the first time this century, the IEA said, sliding by 0.9 per cent to 7.92 billion tonnes, including a more pronounced 2.2 per cent dip in the OECD region. That stands in sharp contrast to the average growth of 4.2 per cent a year in the past decade.

“The coal industry is facing huge pressures, and the main reason is China – but it is not the only reason,” Dr Birol said, pointing to worldwide environmental policies including last weekend’s historic climate agreement in Paris.

The IEA still forecasts global coal use will rise over the next five years, but at a marginal rate of just 0.8 per cent a year. The additional 275 million tonnes of demand would take consumption to 5.81 billion tonnes by 2020.

…..One of the few market bright spots is south-east Asia, where demand is seen growing at 7.8 per cent a year, ahead of Indian consumption growth put at 4.1 per cent.

Demand for coal and oil is likely to decline over the next few decades. Gas will take considerably longer.

Rise of renewable energy

Renewable energy is still in its infancy, but falling costs should ensure that solar power generation will continue to grow. From the International Energy Agency (IEA):

Renewables have grown rapidly in recent years, accompanied by large cost reductions for solar photovoltaics and wind power in particular. The IEA expects renewable electricity generation to increase by a further two-fifths by 2021. However, renewable heat and transport are lagging behind, despite good potential.

Onshore wind is now cheaper than coal and oil.

Rooftop solar is growing increasingly cheap relative to electricity utilities. Deutsche Bank’s Vishal Shah projects a 40% drop in US rooftop solar prices by 2017:

The Rising Impact of Technology

Internet usage is growing rapidly, especially in emerging markets such as India and China.

Internet Usage

Growth of online services

This has a negative impact on mainstream Retail and Media (newspapers and television) but has spawned an array of online services.

  • Online shopping
  • Online payments
  • Search advertising
  • Social media
  • Online dating
  • Online entertainment, whether Netflix or online gaming
Internet Security

Growth in online services have also generated new problems:

  • Large advertisers have expressed concern over the lack of editorial control over content on sites like Youtube and Facebook.
  • Increased hacking and internet-based crime.
  • Cyber-war between states.
  • Expansion of troll factories, twitter-bots, fake news and misinformation.

In turn, these negatives are spawning new growth industries:

  • Internet security
  • Fraud detection for online payment services
  • Surveillance, image recognition and traffic monitoring

Growth of mobile devices

More than 50% of search is now on mobile, according to Google.

Mobile phone usage is even higher, approaching 80% in emerging economies like India.

IDC forecast the biggest growth in smartphone sales will occur in emerging markets, such as India, Indonesia, Russia and China, with China accounting for nearly one-third of the 1.8 billion smartphones expected to be shipped in 2018.

Speech Recognition

The move to mobile with limited keyboards has increased the need for enhanced speech recognition, with Internet giants running vast AI-driven data centers, powering voice recognition applications like Siri (Apple), Alexa (Amazon), Google Now, and Cortana (Microsoft).

Moore’s Law

Falling costs have been boosted by rising sales and development of new technologies. Moore’s Law applies to more than just computer chips.

Moore’s law” is the observation by Intel co-founder Gordon Moore that, over the history of computers, the number of transistors in a dense integrated circuit has doubled approximately every two years. The dollar cost of computing has followed a similar path.

Nvidia (NVDA) claim that CPU (computer processing unit) performance scaling is now slowing, as the creation of denser CPU circuitry runs up against the boundaries of physics, and that advances in processing power will now largely be driven by graphics processing units (GPUs). As the largest manufacturer of GPUs, they may be biased, and only time will tell whether advances in CPU performance continue along Moore’s path.

Moore's Law and CPUs/GPUs
Source: Nvidia brochure 2018

Artificial Intelligence (AI)

AI uses computers to simulate human intelligence. Learning from data — a computer’s version of life experience — is how AI evolves. Deep neural networks require huge computing power to learn to recognize patterns from massive amounts of data.

AI and high-performance computing (HPC) are transforming a number of industries. Self-driving vehicles and drones are set to revolutionize transportation. Advances are being made in health care detection, diagnosis and treatment: enhanced imaging, AI-assisted diagnosis and remote operation. Manufacturing robotics require AI to train more advanced robots. Government security and surveillance agencies use AI to analyze vast quantities of data, whether Internet traffic or video feeds from thousands of locations across a city. China is a leader in surveillance, especially mass real-time facial recognition and traffic monitoring.

Rise of robotics

Development of robotics lagged behind that of computers for several decades but we are now on the cusp of major advances with introduction of driverless cars now imminent and rising use of robotics in manufacturing.

From Reuters:

Robots now perform roughly 10 percent of manufacturing tasks that can be done by machines, according to the Boston Consulting Group. The management consulting firm projected that to rise to about 25 percent of such “automatable” tasks by 2025.

In turn, labor costs stand to drop by 16 percent on average globally over that time, according to the research.

The shift will mean an increasing demand for skilled workers who can operate the machines, said Hal Sirkin, a senior partner at Boston Consulting.

Factory workers “will be higher paid but there will be fewer of them,” Sirkin said.

The trend is likely to continue with expansion in the field of transport, construction, agriculture and services.

Growing middle class in emerging economies

Homi Kharas from Brookings Institute says that China and India are at the forefront of expansion of the global middle class and the world economy can be expected to increasingly rely on these two countries as sources of global demand.

He projects that 66% of the global middle class will reside in Asia by 2030.

A rising middle class is likely to exhibit strong demand for:

  • Consumer durables (housing, appliances, home furnishing and motor vehicles);
  • Communications and infrastructure;
  • Food, especially protein sources like meat and dairy;
  • Beverages;
  • Personal products;
  • Iconic consumer brands;
  • Travel and tourism; and
  • Energy and technology.

The Debt Cycle

We are approaching the end of the four decade long Debt cycle, signaled by the 2008 global financial crisis.

But there are still pockets of rapid debt growth: in China, Australia and Canada. Nils Jenson at Crescat Capital explains:

The Bank for International Settlements (BIS) has identified an important warning signal to identify credit bubbles that are poised to trigger a banking crisis across different countries: Unsustainable credit growth relative to gross domestic product (GDP) in the household and (non-financial) corporate sector. Three large (G-20) countries are flashing warning signals today for impending banking crises based on such imbalances: China, Canada, and Australia….

Pressure on banks to increase capital holdings relative to credit exposure is likely to lower return on equity and slow debt growth.

Low inflation, low interest rates, and low GDP growth are likely consequences.

Passive investing

Passive investing via exchange-traded funds (ETFs) is gaining market share from active managers, reducing investment management and broking fees.

Market risk is expected to increase as ETF investors tend to focus on price performance, ignoring earnings multiples, which encourages the build-up of market excesses.