SUPL - Investing Themes For 2024

2024-01-15 12:40:00 ET

Summary

• All decisions around investing, everything we're seeing everyone doing is now colored by the rate situation.
• Artificial intelligence is a constantly growing and transforming phenomenon.
• Unlike artificial intelligence, a lot of the most exciting areas of medical breakthroughs last year in 2023 really struggled from a performance perspective that rerated valuations.
• The idea of a fragmenting world is something that investors have to think about more and more in their international allocations.

Transcript

Oscar Pulido: Welcome to The Bid, where we break down what's happening in the markets and explore the forces changing the economy and finance. I'm your host, Oscar Pulido.

Benjamin Franklin once said, an investment in knowledge always pays the best interest. So, as we begin a new year, what knowledge will help investors prepare for potential volatility on the one hand, and potential for opportunities on the other?

Joining me today is a Bid regular Jeff Spiegel. US head of Thematics Sector and International ETFs at BlackRock.

Jeff Spiegel: One thing that we have to keep in mind, everything we're seeing everyone doing is now colored by the rate situation. With yields where they are, you have to be a little more thoughtful about taking risk.

Oscar Pulido: To help investors navigate the year ahead, Jeff will provide a holistic overview of three major investment themes, including the emergence of the AI trade, opportunities in medical innovation, and the impact of geopolitical shifts on globalization.

Jeff, welcome back to The Bid.

Jeff Spiegel: Great to be back with you, Oscar.

Oscar Pulido: And Jeff, Happy New Year. It is 2024. I hope you had some time off, before we started the new year?

Jeff Spiegel: Happy New Year to you, Oscar. I've actually been out in Denver for a couple of weeks, visiting my sister who's a veterinarian, which means I was also staying with four chinchillas and a four-pound dog.

Oscar Pulido: So, Jeff, with the new year comes the opportunity to invest in new themes. So, I'm curious, how are you thinking about the year ahead as far as the broad themes that investors should be considering?

Jeff Spiegel: One thing that we have to keep in mind, and this really started last year, is all decisions around investing, everything we're seeing everyone doing is now colored by the rate situation. With yields where they are, frankly, you have to be a little more thoughtful about taking risk, right, if you can capture, four or five, 6% on short-term debt that raises the bar. And so, we think that investors, when they're thinking about the equity side of their allocation, need to be thoughtful about where can they really drive returns. Where is that potential opportunity to get the outperformance that justifies being out of cash and being out of bonds?

And so, when we think about that, there's really three areas. The first is artificial intelligence. I know we've been talking about this for a long time. I did a Bid episode with you last year where we discussed it, but it's a constantly growing and transforming phenomenon. We're really thinking about it as the very early iterations, the concepts, the ChatGPT to real products and enterprise usage and commercialization.

The second is about medical innovation; unlike artificial intelligence, a lot of the most exciting areas of medical breakthroughs last year in 2023 really struggled, from a performance perspective that rerated valuations, and even though we have amazing breakthroughs right in front of us, against cancer, against neurodegenerative conditions, those valuations make really attractive entry points.

And the last is this idea of rewiring globalization. This new megaforce that we've brought to market last year in 2023, the idea of a fragmenting world is something that investors have to think about more and more in their international allocations.

Oscar Pulido: Let's go through some of these themes. You mentioned three of them, but let's start with AI and I was going back through the archives and in fact it was last February that you and I spoke, and we talked about ChatGPT, in fact people might remember that we had ChatGPT join us on the podcast as a special guest. It was a big theme for 2023 as it turns out, and you're saying it's going to be a continued theme in 2024. What are the developments that you expect to see this year? What industries, what sectors are going to benefit from this AI theme?

Jeff Spiegel: We make a lot of predictions, both of us in our work. I think we were both really excited about AI back in February. I think we probably under clubbed it, in terms of how exciting it was going to be, and that excitement really continues. But again, it's shifting, towards a new phase. Last year most people's experience with artificial intelligence was having an amazing conversation with ChatGPT or with Bard and that felt a little bit more like a novelty but was teasing people's idea of what might be possible.

I think going into this year, what you're going to see is, much more commercial applications. That means that if you work in a law office, you're probably going to be using technology that allows you to iterate on contracts incredibly quickly with just text-based inputs, and this idea of text-based inputs is so important because one of the other areas that I think will be transformed is coding. Pretty much anything that you might write in code, you can actually just tell your artificial intelligence what you want it to do, and it'll output that code. So, across industries, you're going to be able to use text language to accomplish incredibly complicated tasks that usually would require some level of coding automation. That could be contract based, that could be marketing and advertising language, so on and so forth. And again, companies are investing not just because AI is cool, though, I think we can all agree it's pretty cool, but largely around cost reductions. When you think about the efficiencies that are created, a coder sort of spending his time or her time, debugging something rather than writing the code from scratch- that's faster, that's powerful. Actually, about 60% of companies who plan to adopt AI are planning to do so for the reasons of cost savings. ⁱ

This is a real imperative in how businesses are being run in generating more revenue and generating more profitability. These productization, these actual use cases in the way that we work, I think that's going to be really powerful.

We've also talked in the last year a lot of the downstream implications and beneficiaries, the picks and shovels, if you will. There were semiconductor companies that were some of the biggest performers around the AI craze. A lot of that specifically semiconductor companies that were responsible for GPUs or graphic processing units. Now, these are really critical when it comes to training AIs, when it comes to crunching massive amounts of information. But we actually think that semiconductor opportunity is really just starting because as we move forward from training artificial intelligence towards what we call inference. You actually need different semiconductors, you need CPUs. That broadens out the opportunity set to a range of other firms. And the way you can think about this is the training process is about learning how to do a math problem. The inference process is actually taking what you've learned and applying it to solving a math problem. As we shift to that phase of artificial intelligence, the semiconductor opportunity only broadens out from here.

And then investors remain really underexposed to a lot of these themes. If you look at the NYSE fact set, robotics and artificial intelligence index, it’s a very small holding in most people's portfolios when you consider pure play companies. From pure play companies under a hundred billion dollars, the average investor is only owning about 1.5% of their portfolio in artificial intelligence, there's a lot of room to grow that allocation, especially as artificial intelligence continues to grow in importance in our lives and in the economy. ⁱⁱ

Oscar Pulido: It is interesting to think back to the conversation we originally had around AI and ChatGPT. You used the word novelty and just thinking about how that discussion around AI evolved in 2023, where we had seemingly this kind of cool toy to play with.

And then, what manifested over the course of the year was all of these real-world applications that it was going to start to apply to. And you started talking about some of those and some of what's to come. You also mentioned medical innovation. So, what are some of the factors that make this sector attractive in terms of valuations, in terms of potential breakthroughs? I'm remembering as well the discussion you and I had around neuroscience and maybe that's one of the areas that you're wanting to discuss.

Jeff Spiegel: It absolutely is. We're quickly entering a world in which there will be more grandparents than grandchildren. Effectively, that's more people over 65 than under the age of 18 ⁱⁱⁱ and, we can actually predict what some of the consequence of that is medically.

We know that in older populations, cancer is significantly more prevalent. We know that in older populations, some of those neurodegenerative conditions we talked about last time, Parkinson's, Alzheimer's, various other forms of dementia are a lot more prevalent. That's a challenge for society, for sure, but it's also an opportunity because we can see it coming, because this is a very predictable force, these aging populations. And so, there's a bunch of breakthroughs in both areas as well as biotechnology broadly. It's not actually just that people are getting older, that age cohort, that baby boomer population is aging up, it's also that people are living longer because medicine is better.

And I would actually predict we're going to accelerate that pretty quickly because a lot of the drugs that we've seen that are combating diabetes and obesity, that's one of the major problems that limits lifespans, particularly in the United States. These drugs are actually going to drive about a hundred billion dollars of additional revenue in the prescription drug market up from about 1.5 trillion today, so almost an 8% increase in the total prescription market just based on these drugs that are going to reduce obesity and therefore extend lives even further. ^iv

But when we think about specifically, how we're going to operate faster, how we're going to operate better, we actually can go back to that artificial intelligence conversation that we were just having. One of the differences from 2023 to this year is when you're playing with ChatGPT, when you're using Bard, these are generative AIs that were trained on the internet, they were trained on public information. What you're going to increasingly see is more specialized artificial intelligence that's trained on specific information. And in medicine, that's going to be one of the most powerful places, naturally medical data is restricted. That's exactly what we want, so it's not available to a GPT or a Bard. But when you use it within a walled garden of a biotechnology company, for example, you can actually get at that.

And so, for example, scientists actually last year, used AI to map a fruit flies’ brain, 150,000 neurons. ^v And this is actually the first animal that we have ever mapped the brain for. How did we do that? We used artificial intelligence to accelerate the process. Now, the human brain is a little bit more complicated, it's more like 86 billion neurons than 150,000 neurons. ^vi But at the speed of which artificial intelligence is improving, we're probably going to be able to map the human brain as well in the near future. Artificial intelligence is driving breakthroughs in one of those areas that we know is going to be such a prevalent problem, which is these neurodegenerative conditions. Because if we can better understand the brain, we can come up with a lot more treatments in those areas.

And then when we think about cancer and drug discovery more broadly, bringing a new drug to market, if you factor in failures, which there's a high fail rate, the average drug actually costs about $2.5 billion in development costs. ^vii It takes about 12 to 15 years on average from development to regulatory approval. ^viii There's only about a one third probability that a drug researched actually is successful, in treating the condition it's intended for. ^ix And then almost a 10% probability that it gets approved by the FDA or whichever governing body. ^x

So, it's incredibly challenging bringing new drugs to market but again, AI can prevent a really nice solution here, which is by 2025, we actually think that over 30% of new drugs are expected to be discovered using generative AI, ^xi which is really good at iterative processes, which is what drug development is often all about, and we think that this can save biotech companies 25 to 50% of their development time, ^xii when you think about that, you're basically saying drugs go from a likelihood of 35%, of being successful over 10 to 12 years, to basically taking that risk only over five to six years. That makes a huge difference in the profitability of biotech companies as well as in the opportunities we're all going to have to have these drugs brought to market sooner for us and for our loved ones.

But when you think about AI a little bit more holistically in healthcare, you could actually think about the patient experience, virtual nursing assistants, AI robot assisted surgeries, health monitoring through wearables, personalized healthcare plans.

You can almost imagine, 'Hey, artificial intelligence, read all of the patient notes on this person, take a look at the patient tests, and then spit out for me a treatment plan' that's where we're headed. And then more diagnostics and more treatments. So, it's not just drug discovery, it's this whole universe of health care that's going to get supercharged at a time that's really important because we know we have that aging population, we know we're going to have those greater health needs.

Oscar Pulido: Just listening to you talk, you've intersected the AI investment theme with a medical, healthcare-oriented investment theme, which is a good reminder that these two things are not interdependent.

They can intersect, and you brought up some good examples. You also talked about an aging population, as I understand it. I just recently heard this, that 2024 is what they're calling Peak 65, which is the year in which the most baby boomers are turning 65 years old. Just to give us a sense of the aging population.

So, for somebody who is a long-term investor, and thinking about investing in the market, what is the impact of this larger and older population?

Jeff Spiegel: So, I think there's two impacts that I would point out. So, one is what we were just discussing. It's very predictable that we're going to see more healthcare spending. It's very predictable that we're going to see more breakthroughs as we invest more to fight those diseases, and we use artificial intelligence to supercharge that process.

The other areas that, this demographic dividend that was effectively paid to the United States and some other countries following World War II because of that baby boom is ending in much of the Western world. It's long over, in a place like Japan. But when you think about large parts of emerging markets, particularly emerging markets outside China, the demographic dividend is only just paying out now. Labor productivity, size of labor force, age of labor force, increasingly, opportunities are a lot more attractive outside of the United States and outside of Western countries because of the disparity in where folks are on this demographic dividend, on this aging curve.

Oscar Pulido: As you talk about the differences in, geographies that, changing demographics are having, it brings up the last theme in the outlook, which is, the rewiring of globalization, which is something that we've seen accelerate post the Pandemic. Again, you've been on here talking about this theme in the past, so tell us a little bit about the countries that you think are poised to benefit from the changing supply chains around the world.

Jeff Spiegel: There's a range of countries that are going to benefit. And, two really important concepts are, friendshoring and nearshoring. So Nearshoring, actually to back up for a second, just to provide context, for 30, 40 years companies really only prioritize cost in the development of their supply chains.

Now they're focusing on resilience for a range of reasons. One, the supply chain disruptions of the Covid Pandemic. Two, an increasingly fraught geopolitical world. A lot has been shown based on what's happened in Ukraine, based on what's happened in Israel, and as a result. That more fraught geopolitical environment means that supply chains around the world are even more at risk.

So as folks think about reorienting these, they want to limit the geopolitical risk and they want to limit the sort of, geographic distance sort of risk. So Nearshoring is bringing production back towards closer to home. And friendshoring is doing more business with countries which you have more free trade agreements or just more positive government relations.

And so, thinking about those two areas, Mexico and India are the two that come to mind. Mexico kind of hits, on all fronts here, right? So really strong free trade agreement with the United States. If you ask executives what are the reasons you want to do more business in Mexico, they'll tell you it's because there's a qualified labor force, they'll tell you because the salaries are attractive, but they'll also tell you in huge numbers because of the proximity to the United States. And then you think about a place like India, and India obviously is a good bit away geographically from the United States, but today it's the world's fifth largest economy. ^xiii

We think by the end of the decade it'll be the world's third largest economy. ^xiv and again, a lot of that growth is driven by what we were talking about, the working age population growing incredibly rapidly, the amount of educated young workers growing incredibly radically, along with being a democratic countries that is good relations with a lot of other democratic countries like the United States, and so we've actually seen about $2 billion flow into India ETFs just over the course of last year. ^xv

But when you zoom out a little bit, Mexico and India are really good examples, but the list goes on, right? You've got Vietnam, Thailand, Indonesia, Brazil, all of whom are benefiting from the near or friendshoring components or both.

And when you also think about the fact that China makes up about 30% of the emerging markets benchmark, ^xvi we're seeing investors increasingly focus on emerging markets ex-China We've actually seen about $4 billion flow into, emerging market ex-China ETFs just over the course of the last 12 months or so. ^xvii you know that growth is incredibly rapid. In fact, emerging markets ex-China is now making up a really large percentage of total flows into emerging market ETFs, this new way of investing, focusing on this wide range of beneficiaries of nearshoring, of friendshoring, and thinking a little bit more about a diversification of supply chains beyond just China.

Oscar Pulido: So, Jeff, maybe just to wrap up, it's been a bumpy few years. We've had Covid, we've emerged from the pandemic, we have a new macro regime that the BlackRock Investment Institute has talked about with higher interest rates. You tend to come on here and give us an optimistic view of the world and think a little bit more long term, so starting off 2024 on the right foot, what are some of the things that investors should be considering to maximize the opportunities that are out there?

Jeff Spiegel: Everything has to be covered by this new yield environment that we're living in. And when you think about in that context, investors really have the luxury of being pickier. If you can lock in fairly safely or very safely, strong yields, it gives you an opportunity in the portfolio to take a bit more risk, but also to be really thoughtful about that risk. That's why we think artificial intelligence, given the sort of expanding out of the opportunity, it's why we see medical breakthroughs given the attractive valuations combined with the supercharging impact of AI combined with some of the really near-term breakthroughs that are right in front of us.

And again, this geopolitical fragmentation, as places where we think investors can take some of that additional risk and be really targeted in equities, and not just as has worked really well for the last decade or so, own the whole market, but own specific markets where they think they can truly drive growth.

And honestly, when I think about these three areas, in a lot of ways, I think the biggest risk is missing the opportunities potentially being left behind. That's this whole idea of mega forces of really thinking forward, of really thinking about the opportunities that are huge, that we know are coming and that we want to make sure we participate in.

Oscar Pulido: Jeff, as always, very insightful. Again, happy New Year. I'm not sure if staying with your sister makes you more likely or less likely to want to have pets, but we do hope you'll rejoin us on the podcast over the course of 2024. Thank you so much for joining us on The Bid today.

Jeff Spiegel: Still love pets, huge animal lover. I don't think I will ever have a chinchilla, much less four Chinchillas, but it was great getting to visit with her over the holiday season and as always, it's great getting to visit with you today, Oscar.

Oscar Pulido: Subscribe to The Bid wherever you get your podcasts.

Sources

ⁱ Slalom, 'AI’s most powerful prompt,' 10/10/23.

ⁱⁱ BlackRock, Morningstar, BlackRock Portfolio Solutions as of June 30, 2022. Starting Portfolio Allocation is representative of advisors’ broad asset allocations for equities, based on analysis of 21,276 portfolios over the 12-month trailing period.

ⁱⁱⁱ Inter Press Service News Agency, 'The Historic Reversal of Populations,' 08/08/2016.

^iv BlackRock, 'Diagnosis: Big opportunity in healthcare stocks,' 07/27/2023.

^v Fortune, 'Scientists just used A.I. to map a fruit fly’s brain. Here’s why it’s a ‘turning point in neuroscience’,' 07/08/2023.

^vi Drug Discovery and Development, 'The Brain Knowledge Platform aims to illumine the brain’s cellular universe,' 06/10/2023.

^vii Morgan Stanley, 'Why Artificial Intelligence Could Speed Drug Discovery,' 09/09/2023.

^viii BCG and Wellcome, Unlocking the potential of AI in Drug Discovery,' June 2023.

^ix Ibid.

^x BCG and Wellcome, Unlocking the potential of AI in Drug Discovery,' June 2023.

^xi Gartner, 'Beyond ChatGPT: The Future of Generative AI for Enterprises,' 01/26/2023. BCG and Wellcome, Unlocking the potential of AI in Drug Discovery,' June 2023.

^xii Ibid.

^xiii World Economic Forum, 'This chart shows the growth of India’s economy,' 09/26/2022.

^xiv The Economic Times, 'India set to be world’s third-largest economy by 2030: S&P Global,' 10/25/2023.

^xv Global Business Intelligence, Bloomberg, as of 10/31/23.

^xvi Morningstar, as of 10/31/2023.

^xvii Global Business Intelligence, Bloomberg, as of 10/31/23.

MKTGSH1223U/M-3285375

Disclosure

This content is for informational purposes only and is not an offer or a solicitation. Reliance upon information in this material is at the sole discretion of the listener.

For full disclosures, go to Blackrock.com/corporate/compliance/bid-disclosures

This post originally appeared on BlackRock.

For further details see: