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In the middle of difficulty lies opportunity

01 April 2020

Mark Hawtin shares his thoughts on the potential opportunities afforded to the technology and disruptive growth sectors amid the Covid-19 outbreak.

The greatest challenges have the ability to deliver the biggest transformations. We anticipate the current wave of disruption to accelerate as we exit the worst of the Covid-19 pandemic. This acceleration could offer an amazing opportunity for investors focusing on this type of disruptive growth opportunities. The title of this piece, taken from a quotation attributed to Albert Einstein, is very apt; there are very few times in an investing career where the opportunity is considered to be outsized. Yet, we believe this is one such occasion.

In our view, the market has reacted to the pandemic in a fairly predictable way. First, there was a sharp decline that delivered a bear market reading (more than -20%) in record time, with most shares moving sharply lower in tandem. The initial hint to us that technology was being treated differently in this environment was that leading technology and high growth names did not fall any more than the market overall. Normally, we would observe high growth names falling much further in the early stages of a sharp sell-off. This first move, in this case, was driven by a combination of panic and a substantial de-gearing from leveraged portfolios.

There were a series of predictable underperformers as the world went into lockdown. Airlines, travel companies and hotel groups were negatively impacted, with some facing the question of their very survival. Simultaneously, measures to curb the epidemic led to major changes in working practices and personal habits that were made possible by the technology world in which we live. Remote working and communication have been driven by the cloud, which provides the ability to function from any location. This would not have been possible just 10 years ago. At the same time, supply chains for essential goods and services have been bolstered by the network of online retailers like Amazon, as well as transportation-as-a-service companies like food delivery. In short, the disruptive growth winners of the past 10 years have become the very backbone to allowing any form of functionality in this unprecedented period of lockdown.

To illustrate this, Microsoft has reported a 775% increase in cloud instances in countries operating an isolation policy. The chief technology officer of Telefonica has said the level of cloud business growth expected over the full 2020 year had in fact occurred within days. AT&T and Verizon, the biggest telecom providers in the US, have seen respective jumps of 27% and 22% in traffic levels. The most obvious beneficiaries, video and voice conferencing, have also exploded – Webex traffic is up 240%, Facebook and WhatsApp messaging is up 50% and video calls are up 200%, to name a few examples. What we find fascinating, however, is that in Asia, where lockdown measures are being relaxed, the levels of remote technology usage remain high. We believe this pandemic may accelerate the structural shift to the cloud, to remote working and to a change in living patterns that could be permanent.

The market has begun to align with this structural accelerated shift. In any normal recession or sharp economic downturn, we would find commodity semiconductors at the heart of the losers list. In this case, the opposite is true. Storage, such as DRAM, NAND and HDD, is sometimes used as a way to gain broad exposure to the trend of data growth and artificial intelligence. While certain names representative of this theme – Siltronic, Micron and Seagate – all fell sharply in a first reaction to the epidemic, they have all recovered to leave Micron down only 15% year-to-date and Seagate -16%. This is highly atypical for a downturn and we believe it is a clear sign of the accelerating trend to the cloud.

Elsewhere, there has been strong relative performance from the cloud infrastructure companies like Amazon and Microsoft, as well as point solution players like Zoom Video, Citrix and Docusign. In fact, these latter three companies are all up on the year by 44%, +32% and +19% respectively.

At present, there is very little clarity on the timing of a return to normality from this horrendous pandemic, and this uncertainty will lead to continued volatility in markets. In particular, the timing of an end to the social distancing strategies has a very significant impact on the possible outcomes for many companies and industries. While governments have, in many cases, put in place a strong financial support structure for a three month period, what happens if social distancing needs to last a lot longer? There are a wide range of outcomes for vulnerable industries like travel, airlines, hotels and high street retailers, ranging from structural change at best to bankruptcy at worse.

There are other industries that we believe will follow a more normal economic growth-impacted path, where the uncertainty of that path is high. There are also those industries that will see significant structural strength. At the heart of that lies disruptive growth and technology, which encompass everything from the providers of those services, like Amazon and Microsoft, to the platform beneficiaries, like Google and Facebook, all the way through to the myriad of supporting players – collaboration tools, video conferencing and cyber-security, all of which contribute to the overall re-tooling of multiple industries to have technology at their core.

A great example of the re-tooling of an existing industry can be seen clearly at Domino’s Pizza, an early digital technology adopter whose business model has changed so dramatically that one could possibly say it is a technology company at its core. As early as 2009, Domino’s began thinking of itself as a technology company that sells pizza. According to their chief digital officer, they wanted to be good with data, to not be afraid to fail and to operate with a speed closer to Amazon than a pizza brand. We find it poetic that on the day the market hit its 2020 peak, 19 February, Domino’s released Q4 2019 numbers that led the share 20%+ higher that day. In our view this illustrates that its technology-centric business model insulates it from the worst of the Covid-19 fallout.

The ultimate point to make here is that, as former Cisco CEO John Chambers advised, all companies must innovate with technology at their core. In our view, as many as 40% of companies could fail in this process, unless they innovate with sufficient force. The Covid-19 epidemic has reinforced this necessity. We believe it may ensure an acceleration of the trend to the use of disruptive technologies. No one knows exactly where the market will bottom out, or whether it may have done so already, but the opportunity this sell-off may afford must not be overlooked.

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Source: GAM unless otherwise stated. The information in this document is given for information purposes only and does not qualify as investment advice. Opinions and assessments contained in this document may change and reflect the point of view of GAM in the current economic environment. No liability shall be accepted for the accuracy and completeness of the information. Past performance is no indicator for the current or future development. The mentioned financial instruments are provided for illustrative purposes only and shall not be considered as a direct offering, investment recommendation or investment advice. Reference to a security is not a recommendation to buy or sell that security. The companies listed were selected from the universe of companies covered by the portfolio managers to assist the reader in better understanding the themes presented. The companies included are not necessarily held by any portfolio or represent any recommendations by the portfolio managers.