Morgan Stanley On Reversion, Evolution, And 2021’s New Normal

From Adam Virgadamo and Michelle Weaver, equity strategists at Morgan Stanley

As we enter 2021, vaccines bring hopes of reopening and a return to normal, but the reality is that markets and the world are constantly evolving. That evolution creates alpha opportunities, so each year Simon Bound, our Global Director of Research, hosts senior analysts from around the world to discuss ideas that will shape investment returns in the years ahead. This year’s meeting over videoconference felt a bit different, but the format didn’t limit the breadth of discussion.

Here are some high-level thoughts on trends that we expect to shape markets in 2021 and beyond.

  • Post-pandemic economies will look different: We see a V-shaped recovery, but history tells us that every recession brings economic scarring. Given the scale of the Great Covid Recession (GCR), this time won’t be different, and how we heal matters. Proactive fiscal policy has been a pillar of the recovery and we expect structurally higher spending going forward, but it will prompt debate. There’s a real possibility that higher spending means higher rates, higher inflation, and sharper and shorter business cycles, all of which come with higher volatility and a broader role for active management.

  • Reopening will bring wallet share shifts: The GCR accelerated digital adoption trends, propelling tech to new all-time highs as a percentage of market cap. A reopening will bring some wallet share reversion, but 2020’s winners won’t sit still and tech’s giants will push to make this year’s share gains permanent. We see opportunities in identifying how much 2021 spending patterns resemble 2020 versus 2019.

  • Covid-19 made us more productive: One trend too powerful for even Covid-19 to derail is the deployment of technology to disrupt existing business models. We’ve written about the coming Productivity Boom, the Data Era, and the 2nd Machine Age, and 2020 saw these secular trends continue with robust demand for investment in AI, automation, and industrial software. The application of technology in response to the pandemic led to new ways of operating that made companies more efficient and protected their margins. We suspect that these efficiency gains are just the beginning as the continued diffusion of technology across industries boosts productivity for years to come.

  • Disruption isn’t stopping: As an example, Alibaba digitized retail and logistics in China. Manufacturing may be next as BABA’s scale and data give it the ability to predict demand and reduce costs upstream via better inventory management. Downstream, the reach of social networks means it’s never been easier to build a brand or harder to maintain one, raising questions about the benefits of scale and the long-term value of brand equity. Social commerce and community purchasing are also evolving in ways that help to shift advertising dollars and lower the cost of last mile delivery, opening new markets. Given rapid evolutions on these fronts in China, we think that global investors should watch closely as good ideas tend to be exported quickly.

  • Tech is a differentiator: New ways of operating and higher productivity also raise questions about whether the market is appropriately valuing the embedded tech within companies. Covid-19 may have been a catalyst for change to unlock this value – our Data Era basket of companies investing in tech to generate shareholder value has outperformed the market by ~25% since Covid-19’s onset.

  • Rate of change ESG investing is going mainstream: With more money moving into ESG, pure play green investments have seen valuations skyrocket – across our US clean energy coverage, average EV/EBITDA multiples were up ~440% in 2020. Is a fundamental shift in the valuation of green assets under way? Will premium ‘green’ valuations create a halo effect for companies trying to become ‘greener’? We think that the power behind green investing and the common sense investment approach of buying at lower prices mean that the market may embrace rate of change ESG investing and reward companies improving their ESG characteristics. To that end, we’re adding an ESG element specifically focused on rate of change to our Risk Reward 2.0 platform across our global coverage to help clients spot these inflections early.

  • Policy debates don’t end with elections: With a new US administration taking office, we’ll have a lot to discuss on policy in the coming year, but here are two broader policy topics to monitor: (1) A push for green investment and first-mover penalties mean that the tariffs we focus on next may be carbon border adjustment taxes. (2) As humans increasingly encroach on animal lands, zoonotic disease transmission is increasing. How prepared are our healthcare systems and policymakers for the ‘next pandemic’?

We hope that 2021 brings some return to normal. We also know that with change as a constant in our line of work, 2021’s normal will be different. As the world both reverts and evolves, we look forward to leveraging our global footprint and collaborative DNA to help our clients generate alpha in 2021 and beyond.

Enjoy your Sunday and best of luck this year.