Investment Outlook 2018
How disruptive innovation is shaping our world
Global economic growth should accelerate in 2018 from around 3.2% in 2017 to 3.4%, as previous laggards in the Eurozone, Latin America and Asia catch up
As a result we will see synchronised growth across the world for the first time in many years. Company earnings across all major markets also look strong.
So should investors just sit back, relax and let the good times roll? Not a bit of it. Stock markets have risen to all-time-highs in many places on the back of better economic and earnings data and are reliant on these trends. As growth rises, so central banks in the US, the UK and Europe are set to withdraw some of the extraordinary measures introduced in the wake of the Great Financial Crisis of 10 years ago. And markets have also moved higher in spite of some major political challenges, from Brexit to Trump to North Korea.
On an even more fundamental level, however, the world is changing in amazing ways with disruption caused by technological advancements and new business models at the heart of it. These companies are able to deliver products and services more simply and more cheaply than the incumbents and are shaking some sectors to the core. As an example, whilst it took Hilton 90 years to get to 1 million rooms, Airbnb got to 3m in fewer than 10. And whilst fifty years ago the three largest companies in the world were car makers in the city of Detroit, they are now software firms in Silicon Valley.
In our Outlook 2018 document we examine how these changes could affect us and our investment portfolios, ranging from the threat to existing car makers from the growth of electric cars, to the potential of robotics to make our lives easier. We also touch on some of the darker aspects, including the costs of cybercrime and the threat to jobs from automation.
Whatever the future looks like, we as investors must be constantly vigilant about the changes taking place and keep looking for threats to existing franchises and opportunities to invest in new ones.
Head Of Adam Investment
The rising dominance of tech giants is starting to concern governments and regulators.
The 1984 advert for the Apple Macintosh computer showed a woman evading a shadowy police force to throw a hammer into the face of Big Brother, who was broadcasting commands to an army of grey drones.
To those watching at the time the message was inescapable. IBM, which had a virtual monopoly during the mainframe computer era, was trying to dictate standards at the start of the personal computer era. People had to ‘Think Different’ and buy an Apple Mac.
More than 30 years on, you could be forgiven for thinking that Apple is now the monopolist. They don’t dominate in terms of market share, but they account for over 80% of all the profits in the mobile phone industry with the iPhone killing off incumbents Nokia and Blackberry. Samsung is the only other company making money. Apple tie in customers with their closed ecosystem – for example your iTunes purchases won’t work on other software and all third party software makers must bow to their terms and conditions.
Other tech companies which dominate our lives have also become incredibly rich and powerful. How much do you think Facebook earns? You are almost certainly incorrect. They only listed in 2012, yet will make an estimated $24bn in 2018. Google should make $43bn this year. They own the data we generate when we use their services – liking things on Facebook lets them understand what items or services we might wish to purchase. This allows them to sell advertising to these companies and target ads to only the screens of those most interested in a subject.
Classical economics would suggest that these huge profits would attract new entrants, but why would anyone use another social networking site when Facebook connects you to 1.3bn people? Why use another search engine when Google is so good? Furthermore they have the resources to buy up any emerging competition – Facebook bought WhatsApp and Instagram for example.
Their ownership of all this data means they are in effect monopolies, as evidenced by the fact that they take around 99% of the growth of these targeted on line adverts.
Could these tech titans be seen as the new ‘Robber Barons’, killing competition and abusing their monopoly ownership of the terabytes of data we generate? Could profits be regulated away like previous monopolies Standard Oil and US Steel were 100 years ago?
Authorities do indeed seem to be taking action against them – the EU fined Google €2.4bn for manipulating search results and is now investigating their Android mobile phone monopoly, whilst Germany is investigating Facebook for similarly abusing the data it gathers. The discovery of Russian money using Facebook to target voters in swing states in the 2016 US election could also have serious repercussions.
Whilst there is little political will to break up these companies, regulatory action designed to force them to share their data seems the only way to stop their continued dominance and allow new competition. It goes without saying that such action would be bad news for future cash flows, earnings and share prices if it were to happen.
Rise Of The Robots
The fourth industrial revolution is upon us, bringing both threats and opportunities. The sci-fi film Blade Runner – released in 1982 but set in our present day – and its recent sequel Blade Runner 2049 both promised a future where we would be surrounded by androids so sophisticated we would be unable to tell the difference between them and us.
We are not there – not yet – however, slowly but surely, robots and automation are creeping into our lives. Following steam, electricity, and computing, we appear to be at the dawn of a Fourth Industrial Revolution.
Much of their use currently is for the manufacture of automobiles; indeed around 40% of all robots globally are used in this way. The first reason is precision. Japanese car companies pioneered their use in the 1950s and today still have the most advanced robotics – they are faster than humans at repetitive tasks like welding and far more accurate. Furthermore they don’t need tea breaks, or sleep, or pay rises. The machines helped create the perception of Japanese quality and the high productivity of the manufacturing lines kept costs low. Ultimately rival car makers in the USA and the UK failed to adapt and many went bankrupt.
The downside of this trend is the fear that workers will lose their jobs to automation. Politicians such as Jeremy Corbyn and the likes of Bill Gates and Stephen Hawking have argued for a tax when a company replaces a human job with a robot. This could finance a basic living income payable to all. There are also worries that workers could revolt against the introduction of robots, much as the Luddites did by destroying their textile machinery.
Could this threat to jobs be exaggerated? After all, according to economist James Bessen, only one of the 270 jobs listed in the 1950 US census has been fully eliminated by automation – the elevator operator.
Robotics should help productivity
Businesses seem to have learned that the key to improving productivity is to use automation in conjunction with human workers. Think of Henry Ford’s car plant or the automation the Luddites opposed. Ultimately this helped lower the price of goods to the point at which the workers could afford to buy them. Demand soared and jobs and wealth were created, a great example of how improving productivity leads to rising wealth in the long term.
Another example is Smith & Nephew’s NAVIO robotic surgery tools which help a surgeon to make incisions more precisely in knee operations – the patient has less scarring and heals more quickly, allowing the surgeon to do more operations in a day.
They are also very good at performing both dangerous tasks – mine sweeping or mining – and dull ones such as mowing the lawn or vacuuming the house.
Why are analysts so optimistic about their adoption going forward? The increasing processing power of computers, and better data analysis, when combined with advances in relatively cheap sensor technology should allow manufacturers to become far more efficient and so justify the investment in robotics.
The other reason for optimism on their growth is demographics. The Japanese workforce is now shrinking due to an ageing population. Germany and China will be in this position too in the near future. There will be fewer and fewer people working to pay for the retirees’ pensions and cost of care. For example, Japanese company Suzumo (company motto – ‘We love rice!’) has automated that most Japanese of tasks – making sushi. Its counter top ‘sushi-bot’ can make 4,800 mounds of rice per hour without cutting a single grain.
We tend to think of robots as physical but they are increasingly virtual. This fourth industrial revolution can also be seen to encompass Machine Learning, Artificial Intelligence and Virtual Reality. Think of voice recognition recently introduced by banks – including Adam & Company – to check the identify of their clients, or auto pilots in airplanes or the developments in self driving cars. These will help us to cut fraud and – given human error is by far the biggest cause of plane and car crashes – will save lives.
Are there dangers ahead beyond fears of lost jobs?
Do wars become more likely when the only things at risk are drones and robot armies? No less a figure than Elon Musk of PayPal, SpaceX and Tesla Motors fame has said he is haunted by fears of Artificial Intelligence and robots taking over, perhaps influenced by his love of films like Blade Runner or Terminator.
We are a long way from that (we hope!) but it is becoming clear the Fourth Industrial Revolution will make our lives simultaneously easier and more challenging.
Social media companies have gone from keeping in touch with friends to the sole source of news for many. When an obscure German friar pinned his criticisms of the church on the doors of Wittenberg Cathedral 500 years ago, he intended to improve religion and make it accessible to all – ‘a priesthood of all believers’. Carried by the recently invented printing press, Martin Luther’s message went viral and produced chaos, polarisation and religious wars which continued for years to come.
In a similar way, the people behind the best-known names in technology such as Facebook, Twitter and Google had a vision to bring humans closer together. It turns out that if you create a connected world, however, fake news and extreme views are likely to go viral around the world while the truth – to quote Mark Twain – ‘is still getting its boots on’.
Social media started off as the modern day ‘water cooler’ – a place to interact with friends and colleagues to catch up on office news or celebrity gossip, and such behaviour is generally seen as good for business and society as it also allows new ideas to form and spread, and personal and work relationships to be built. After all, Microsoft paid $26bn for the social network for business LinkedIn, and the most common way for couples to meet now is via online platforms.
The role of social media in our lives has changed
Whilst businesses may worry about the effect of these on productivity in the work place – according to studies, millennials spend 2 hours a day on social media (that’s a lot of cat videos) and interact with their phones 157 times on average – they were initially seen as a harmless way of keeping in touch with friends.
This attitude has started to change in the past few years, however, as they have morphed from meeting places into trusted media platforms and for many, social media are now their only source of news. Gone are the days when you would purchase a morning paper or view the 10 o’clock news to find out what is happening in the world – you can get as much news as you want and from any source you choose to follow at the click of a button.
Whilst it could be argued that these social media platforms have led to an increase in the freedom of speech and have given power to the people (just think of their role in the spread of the Arab Spring in 2011), the resulting decentralization and democratization of journalism also means that no one has responsibility for performing due diligence on stories to check their veracity.
The companies claim to be platform providers, rather than media companies, however, and therefore have no responsibility for the content which is published on them. This position is now coming under severe pressure as it is becoming increasingly clear that they have the potential to cause harm to society. From fatal outbreaks of measles being blamed on online anti-vaccination campaigns, to spreading terrorist propaganda, the dangers are multiple, even putting democracy at risk with Russia financing a social media campaign in swing states in the 2016 US Presidential election.
The beneficiary of that campaign, Donald Trump, and his love of Twitter worries many. It is hard to get subtleties across in 280 characters or less, to the point that North Korea wondered aloud if a tweet in September last year (2017) was a declaration of war.
For the moment, the platforms in the western democracies have largely escaped rules
However the existing state of affairs does not seem to be working, not only from a fake news perspective, but also from increasing levels of cyber bullying, hate speech, and indecent images being shared, to say nothing of the worries about the huge amount of personal data they collect from us and how they use it.
The tech companies are starting to react with self-regulation, and many thousands of jobs are being added to try to weed out fake news and illegal activities as well as trying to do a better job of shining a light on the organisations behind targeted political adverts. However, formal regulation is still a long way behind that which governs other media such as newspapers and television. No politician or regulator is suggesting that we follow the lead of China and introduce a ‘Great Firewall’ to censor content centrally, but despite their continuing popularity with users, we may be entering more worrying times for those in charge of social media networks.
Cash Is (Not) King
Digital technologies are redefining what the world considers as money.
The Mesopotamians used clay tablets 5,000 years ago. The English used Tally sticks made from willow. The Spanish literally dug theirs out of the ground from the Cerro Rico (‘Rich Hill’) in the Bolivian city of Potosì, extracting 45,000 tons of silver to mint their famous Pieces of Eight. And money in the UK is now a sliver of polymer film.
Whatever form it comes in, money is not about to change as a concept – a means of exchange for goods and services. However the physical nature of it is currently changing in ways scarcely imaginable a few years ago and may in time be entirely digital.
The digitisation of money was really jump started with the invention of the payment card in the 1950s. It became fully digital in the 1970s as the magnetic strip carried information which allowed the electronic reconciliation of transactions.
It is not just cards, however. The leading payment processor, Worldpay, now supports 326 different ways to pay. Mobile payments and mobile wallet adoption is proliferating globally and Worldpay expects them to be the largest single payment method for e-commerce in 5 years. This a simple way to carry credit or debit card information in a digital form on a mobile device. The mobile industry is now taking the lead in re-defining the way we make payments with the integration of coupons and other promotions further boosting their appeal.
Digitisation is far advanced in Emerging Economies
Digital adoption in Emerging Markets is often ahead of the Western countries, especially in the area of mobile payments. Kenya’s M-Pesa, which was developed by Vodafone subsidiary Safaricon, was launched back in 2007. It allows Kenyans to use their phones to send money, withdraw cash, pay a bill, or buy goods and services, and all without the need to have a bank account.
The economist Tim Harford noted that when M-Pesa was introduced in Afghanistan, the police officers believed that they had been given a pay rise. In actual fact, it was simply that their superiors were no longer able to skim cash from their pay packets before they were handed out and around 30% of their pay had been disappearing before it reached them.
Cash continues to be popular with around 45% of UK payment volumes, but it is in sharp decline relative to digital payments. Governments dislike cash due to the potential for fraud mentioned above – physical cash can be hard to trace and so can help foster bribery and corruption and other serious offences such as terrorist financing. Governments globally are therefore very keen to go fully digital and may phase out large denomination notes to encourage this move.
Retailers also welcome this. The psychological ‘pain of payment’ identified by researchers, when consumers have to hand over cash to make a purchase, means paying electronically appears to be easier as it feels less real and this seems to encourage higher spending.
And finally there is no doubt that consumers find making electronic payments more convenient than carrying around the cash they need and standing in a queue to get more when they run out.
Some countries have travelled much further down the cashless route than others. According to the Riksbank in Sweden in 2016 only 2% of the value of all payments in Sweden was made by cash and almost half of Sweden’s bank branches no longer keep cash on hand, or take deposits. And the trend exists from West to East, given that at Chinese New Year in 2017, 14bn of China’s traditional cash-filled ‘red envelopes’ were virtual ‘red packets’.
Beyond this, we now have ‘Cryptocurrencies’ which have no physical form, but are balances kept on a public ledger in the cloud and are operated by a decentralised authority, rather than by governments and central banks. The cryptocurrency space is now valued at several hundred billion dollars and there are over 100 now in existence, with the best known being Bitcoin.
Concerns around cryptocurrencies would include the lack of regulation and some countries are trying to curb their use due to links with fraudulent activities - governments fundamentally do not like the fact they cannot trace or control the supply of this form of money. Security and the lack of a trusted third-party are also worries – transactions are permanent and irreversible with no one to refund your money if your Bitcoin gets lost.
No form of money is perfect but the direction is to digital
Some may mourn the death of cash – perhaps through a distrust of anything virtual – but the truth is that we are irreversibly finding ourselves in a world where our money cash exists not as a physical thing but as a mobile wallet on your phone, iPad or watch, or as encrypted keys in the cloud.
The industry is irrational and ripe for disruption – electrification is the most significant.
The world’s fastest and most expensive production car, the Bugatti Chiron, costs $2.7m yet is powered by technology invented by Daimler and Maybach 20 years before the death of Queen Victoria. The car industry they kick started now turns over $7 trillion when you combine the $2.5 trillion in new car sales with the $4.5 trillion in fuel, servicing, finance costs and so on. It’s hugely important to Germany (over 15% of their stock market is in auto companies) and Japan (10%).
As well as the sheer size of the auto industry, it is also deeply irrational. According to Merrill Lynch, cars cost their owners an average of over $8,000 a year due to depreciation and other costs of ownership and yet they sit completely unused over 95% of their lives. 1.2m people across the globe lose their lives in motor vehicle accidents and pollution in the form of particulates provokes around 40,000 early deaths a year in the UK according to the Department of Health. Finally, they are the biggest man-made contributor to global warming gases.
In short, this is an industry ripe for disruption and emerging trends such as autonomous driving, cars-on-demand, connectivity and electric powered cars are set to do just that. Of these, the latter is by far the most profound change for the industry.
Challenges to the adoption of electric vehicles abound in the short term – they are expensive to buy; the charging infrastructure is poor; we will need more power plants. Cars are also quite emotional things for many and passions on this subject have been as high as when Bob Dylan also went electric 50 years ago.
Their rise is inevitable however. The real question is whether governments ban oil-powered cars first or whether falling prices and improving practicalities mean that consumers simply switch to electric.
One reason for the inevitability of the transition is due to the falling costs of producing electric cars. The underpinnings of oil powered cars consist of around 2,000 parts, 700 of which move. This makes them difficult to mass produce.
Electric cars are far simpler – they are moved by an electric motor consisting of copper wire and some magnets, with the energy coming from a massive rechargeable battery pack – this motor has one moving part.
The battery pack in the best electric cars is easily the most expensive single component, and is thought to be somewhere between a quarter and a third of the total cost of the entire car. These battery prices are falling by up to 20% per year, however, due to mass production and a few technology breakthroughs. Analysts forecast that based on these trends, electric vehicles will cost the same as combustion cars as soon as 2025.
Projections by Bloomberg New Energy Finance suggest that these falling costs will lead to soaring demand in the developed world, with traditional auto sales falling to less than 50% of global demand around 10 years after this.
The challenge to existing car and parts makers is huge
Whilst all car makers have plans to electrify their fleets, the challenges in terms of finance and logistics are huge. The world’s largest car maker has 120 plants, 625,000 employees and a finance division with many tens of billions of loans backed by the value of its cars. How much will it cost to electrify the plants, how many employees will it need (surely far fewer) and what happens to the price of second hand combustion engined cars which underpin the loans in the finance division?
All incumbent car makers face this challenge and will be forced to divert huge sums to research and development as well as the basic costs of electrifying their plants. Their suppliers will be greatly affected too: valves, exhausts, gears and hundreds of other parts will simply not be needed anymore.
The barriers to entering the car industry are set to fall
A further disruption is that there will be new rivals as the barriers to entry to the industry will suddenly get much lower due to the machines becoming simpler – will engineering expertise built over decades be needed when the value-added moves to the capacity of the battery and the cleverness of the software which makes the car move? As an illustration, companies as diverse as Google and Dyson are likely to enter the market.
Another industry which benefits from the current situation is oil, with around 50% of oil production being burnt in internal combustion engines. We will surely see oil demand peak in the coming decade, though few oil industry analysts are worried at this stage as other sources of demand such as jet engines and shipping should prevent demand falling away quickly.
Electrification of personal transport seems inevitable; and the real debate seems to be around how quickly industry and society will adapt and whether the incumbents can survive and prosper or be swept away by the revolution.
The sharp fall in the price of renewables is challenging incumbent energy generators.
The most expensive scientific experiment in the world is slowly emerging from a construction site in an otherwise sleepy village in Provence, France. Whilst conventional nuclear reactors harness energy released when an atom is split, the International Thermonuclear Experimental Reactor or ITER heats atoms up to 150 million degrees celsius in an attempt to generate power from fusing them together.
Some question the science behind the project, but many more now question the cost – this single reactor will cost £20bn. The astonishingly complex and expensive technology behind ITER is in stark contrast to the more mundane and cheap methods currently threatening to disrupt the current system.
When you ask energy companies about their concerns, the potential disruption from nuclear fusion reactors is not on their radar, not least because it is so far off – the fusion experiments at ITER won’t start until 2035. Of more pressing concern to them is the fusion reactor at the centre of our solar system which rains dozens of terra watt hours of free power on to the Earth every day, and the falling cost of capturing this.
The collapse in the price of this power through solar panels is one threat to the traditional model of the energy companies – generate power centrally in big plants, and distribute it on vast electricity grids – as more residential and business customers ‘cut the cord’ and go off grid. Solar power plants are already cheaper than coal plants in 75% of US states and cheaper than gas powered plants in 50% of US states.
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The main argument against solar is the intermittency of generation
The sun shines in the day when you are at work and goes down when you go home in the evening and need it. This challenge is being addressed with the addition of batteries, both at the domestic level – households can buy a battery to store power generated in daylight for use at night – and as more of the vast solar farms are being combined with battery farms too. Furthermore, increasing use of themo-voltaic panels (which generate power from warmth rather than direct sunlight) means that power can be generated even if the sun does not shine.
The UK sees a drop off in such power during the winter months; however wind power tends to rise at this time of year, offsetting much of this loss of solar and thermo power.
Wind capacity continues to grow sharply across the globe as the price of onshore and offshore wind farms continue to decline. Amongst the factors for this are the increasing size and efficiency of the blades and turbines themselves, as well as the ability to put more offshore due to improvements in the construction process – offshore winds are stronger and more predictable. To highlight the declining costs, the most recent contracts for offshore wind in the UK have been struck at prices which are around 40% lower per megawatt-hour than those agreed for the proposed Hinkley Point C atomic power plant.
The intermittency of wind generation is a challenge, but again the falling costs of large capacity batteries should improve this in coming years and much of the additional capacity is offshore.
In the UK the moves can be seen in the changes in our energy mix
Taken together, power from wind and solar has tripled in the past five years and in 2016 the UK’s generation from solar power (5.2% of total generation) surpassed that from coal (4.7%) for the first time in April to September of that year – an astonishing turn around in fortunes for both these fuels.
Whilst it may be several years before residential customers have solar panels, wind turbines and a home battery, at the industrial level the threat is visible now. For example, the world’s largest factory – the Tesla battery plant in Nevada – is entirely off grid due to the solar panels on its roof and the wind farm surrounding it.
Proving the maxim that ‘in muck there’s brass’, Energy from Waste (EfW) is also a disrupter. Household waste which cannot be recycled is increasingly being used as a fuel for power generation rather than being dumped in hugely expensive land fill. The producers are paid to remove and recycle the rubbish, and are then paid to produce power from it. The largest player in the UK currently has 8 such EfW sites, with 4 more under construction, and already one of the UK’s largest industrial sites – the Ineos chemical plant in Runcorn – gets 20% of its power in this way with more capacity to come soon.
We will still need an electricity grid to carry excess power generation from those producing it to those who need it, yet whilst high-profile projects such as ITER and the new UK nuclear plants will continue to make headlines in coming years, slowly but surely the world is moving to newer, cheaper technologies.
Dickson Anderson|Head of Adam Investment
Dickson has over 25 years’ experience in senior business leadership roles within financial services in the UK and Europe. Prior to joining Adam he held positions with Franklin Templeton, Scottish Widows Investment Partnership and Robson Rhodes, as well as investment trust directorships.
Stuart has 19 years’ experience as an investment manager covering Japanese equities, global healthcare and technology stocks. He runs portfolios for private clients and charities, and is a member of the Adam Proposition Board.
With more than ten years of investment management experience and a research background, Kay manages portfolios for private clients and trusts. She also has a key responsibility for research and is a member of the Adam Proposition Board.
Dugald is primarily responsible for managing portfolios for private clients, pension funds and charities on a discretionary basis. Dugald has over 27 years of investment experience. Prior to Adam & Company, he worked in portfolio management for stockbroking firms in London and Glasgow.
Susan Boyd|Executive Director
Susan has over 25 years’ investment experience, managing private client and institutional portfolios. In addition to her own client portfolios, Susan has responsibility for client service across the Adam investment client base and is a member of the Adam Proposition Board.
Mark Ivory|Executive Director
Mark chairs the Adam Proposition Board, and has over 15 years’ experience managing private client and charity portfolios in London, Melbourne and Edinburgh. His primary role is to oversee the investment process and manage client portfolios
Simon has spent over 30 years working in the investment business. He began as an institutional investment manager running money in the UK and then Japan. Simon joined Adam & Company in 2010. He has a wealth of experience managing private client portfolios, trusts, charities and pension funds.
Ken has over 28 years’ experience in private client investment management and advice, managing portfolios for a wide range of clients all over the UK. He previously held senior positions with Turcan Connell, Edinburgh Fund Managers and Alan Steel Asset Management.
Linsey McWalter|Associate Director
Linsey is primarily responsible for the management of discretionary investment portfolios for private clients, family trusts, SIPPs and charities. Linsey is also involved in screening and researching UK equities for client portfolios. Linsey has worked for Adam & Company for 11 years.
Payment technologies change how we perceive money and robotics will change jobs for many. However, not all changes involve complexity – hundreds of moving parts in cars will be replaced by simple electric motors. Furthermore, a new renewable technologies will generate power far cheaper than new nuclear.
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