Thematic Investing and Mega Trends
What is a "mega-trend" and how to position for them? Also - Q2 GDP Overview and Fiscal push/pull
What is a “megatrend”?
I did not get to explain the concept of how I look at thematic investing in my first two pieces, so I’m using this as an opportunity to do so. A couple months ago, I mentioned on Twitter what I thought were the current themes with potential to become megatrends for the 2020s:
1. Triphasic Artificial Intelligence/Machine Learning Scaling, which I wrote about back in May and June here
2. Proliferation of peptide pharmaceutical drugs, specifically in the treatment of Obesity, resulting in a sustained downtrend in the obesity rate by 2033 (what this article is about)
3. US “Fiscal Primacy” & “Legislative Pull”, a phenomenon in the US) that I propose will involve a significantly outsized economic impact from fiscal policy relative to monetary policy that involves the “pulling forward” of domestic CapEx spending due to the Inflation Reduction Act, as well as the Bipartisan Infrastructure Law and the CHIPS Act. The death of “fiscal discipline” as a political issue and bipartisan acceptance of deficit spending will mean that, despite increasing partisanship, both sides will aim to pass fiscally stimulative legislation benefitting their own states rather than attempt to repeal the opposing parties’ legislation. “Friendshoring”, “re-shoring”, clean energy subsidies and semiconductor independence fit into this category as well.
4. Premiumization & “Hyperindividualization” Persistent consumer demand in luxury goods across the top 3 quintiles of earners for premium tier cosmetics, skincare, fragrances and designer fashion, with the U.S. fragrance and skincare market stealing market share from other areas of cosmetics and accelerating their market CAGR for the rest of the decade
Understanding the likelihood, timeframe and magnitude of these trends and their far-reaching implications in a manner that can be exploited profitably demands more time than usual. A framework for understanding how one of these paradigm shifts plays out pays dividends when it comes time to decide whether to truncate the right tail or not. They tend to be the most time consuming and hardest to pin down, but they also tend to be the most rewarding. So, in order to ensure you’re getting your money’s worth I will be doing deep dives, about 2-3 a year, that include a framework for evaluating stocks you may already own or wish to own, an overview of the theme and how it effects the broader investment environment, a deep dive into not just companies that experience a tailwind because of it but those that may be negatively affected and a basket of international equities I am using to capture the theme.
I always attempt to analyze these themes in a manner that maximizes reward and minimizes risk. Instead of looking to a future where there are two scenarios, one in which the trend materializes and plays out well and one in which it doesn’t, I like to ensure the basket capturing the trend can outperform the broader equity market in a number of scenarios. Artificial Intelligence may scale exponentially or it may not, but overall it will scale and this inflection has occurred alongside what appeared to be a cyclical trough in many semiconductor subsectors (optical, GPU, datacenter infrastructure). Regardless of what happens, AI exists and will scale, so instead of attempting to shoot for the moon and create an index of stocks in which that is the only scenario it outperforms, I attempt to overweight the “picks and shovels”. This framework based approach has served me well in the past and I hope it serves your needs as well.
Thematic Investing and Mega-Trend Deep Dives
Or, “Why is this so long?”
We investors are typically inundated with information daily, regardless of how busy or important the day is, and maybe 2% of it will end up being actionable. This has been an issue for a while (see my piece on how it effected the bond market’s signal value in WWI here). My goal with this newsletter is not to add to the noise but rather provide timely signal value that’s easy to process (which is why I have been using Substack’s chat feature, here, to update on news related to names in the thematic baskets as well as more tactical positioning overviews - if you’re a subscriber please check it out).
My long form writing is primarily focused on these “mega-trends”. That is, themes of a certain magnitude and staying power that are worth thinking about beyond what fits in a few paragraphs. Examples of megatrends in the past include the digital revolution and personal (and later mobile) computing, the disinflationary impact of NAFTA and China’s economic development, the gravity defying ascendancy of the southeast Asian Tiger Economies, the economic shock and awe policies following the Global Financial Crisis and impact of quantitative easing, ZIRP and NIRP globally since, the demographic decline of developed markets and the melange clean/green/renewable foci amidst carbon concerns.
For me, in order to warrant an entire long-form post, there is a high hurdle. I’m a big believer that best pitches on individual situations should be inherently easy to communicate, able to be summed up in a couple sentences.
If I was capable of doing so that efficiently (I’m not), every insight I provided would be something like this:
While my actual analysis on that situation may have been in depth, the pitch in October 2022 was simple. One sentence could be expounded to a paragraph conveying the following:
“Here’s a situation: interest rates are headed 500 bps higher, off the zero lower bound - a historic rate of change that, in previous instances, resulted in issues for financial institutions poorly prepared for interest rate risk. Here’s a financial institution poorly prepared for interest rate risk: holistically speaking, it has leveraged a highly convex bet on sustained lower rates in three areas: the flightiness of its concentrated depositor base is positively correlated to rising interest rates, it has extended sweetheart loans to grow deposits rapidly and most of its HTM portfolio is in agency MBS that have progressively become longer and longer duration as rates rose. Commonly accepted ratios for expressing capitalization have not been sufficient to highlight to the market the severity of this situation nor prompt it to discount the bank’s equity to reflect that marking this bank’s entire balance sheet to market reveals they are one bad day from being effectively insolvent. Here’s a play: short the equity.”
The problem is that trends are a bit more difficult. You don’t get a balance sheet or income statement for the whole theme, you have to weigh a number of variables across industries and individual companies. While a pitch like the one for SVB generally fits well into thematic trends (short SIVB equity as part of the wider macroeconomic theme of high inflation and rapidly higher interest rates following years of ZIRP fueled speculation), the themes tend to be transient by nature, their momentum comes and goes and the wide-reaching outcomes five are varied and difficult to predict. They’re not the kind of thing you base far reaching implications off of.
On rare occasions, however, themes begin to become persistent in a way that makes them, or at least their effects, easier to extrapolate. Mega-trends typically occur in some sort of virtuous cycle, reflexively feeding into their own propagation and the creation of new virtuous cycles in other industries, asset classes and/or markets. This is all to say that when a theme becomes a trend becomes a megatrend it makes itself known and it is a phenomenon for which, I find, the costs of analytical brevity begin to outweigh the benefits.
My goal with writing these up is to provide a framework for investors, while being mindful of the potential pitfalls of hyped up themes that will ultimately have very little market impact on a longer timeframe.
The Gartner Hype Cycle is the enemy of the mega-trend, as investors can be correct on determining the magnitude of the paradigm but ultimately lose out by buying at the peak of inflated expectations and selling during the trough of disillusionment. Alternatively, correctly determining the difference between market themes destined to fade and mega-trends can provide investors with amazing buying opportunities.
So, if that seems like something that appeals to you, I’ll be providing that, summaries of important econ prints, various market memos at what I believe are inflection points and explainers on trades that I like from a cross-asset market agnostic perspective that makes up my own approach to investing and trading.