The right place this year has been in tech, above all for EM investors with the sector now over a quarter of the MSCI index and accounting for almost half of total performance YTD. The rise of ‘embedded intelligence’ as vision and other sensors enabled by AI software become ubiquitous has been a key theme of ours in recent years, and has attracted a belated consensus frenzy this year, with pure play stocks from Nvidia in the US to iFlytek in China soaring. However, the growth into value tilt we’ve suggested since the summer applies within as well as across sectors. There has been a pretty spectacular valuation arbitrage as new hardware technology and business models are adopted from retail to autos, among incumbents who sit on a fraction of the multiples of the perceived pure play tech leaders. We will see a similar trend in banking/insurance over the next couple of years as fintech startups broadly disappoint, but their innovations slash operating and customer acquisition costs for the more far sighted established names.
The global auto sector has rallied hard since the summer, partly because investors are waking up to the fact that several automakers have very undervalued IP in the EV/AV/transportation as a service space that offsets the wider industry stranded asset risk. This reflects the historical pattern as innovation diffuses – the re-rating opportunity from tech will increasingly be among incumbents adopting new technology to boost competitiveness, from Japanese banks like SBI experimenting with blockchain/crypto payments to car makers like GM, Toyota or Ford able to scale EV/AV roll out better than Tesla ever can. Selling digital advertising via click-bait news feeds is infinitely easier than mass manufacturing.
Indeed, the aggregation effects that fuelled social media/search and e-commerce platforms are not generally relevant in hardware, which tends to get commoditized rapidly. From an investment perspective we’ll have a multiplicity of overlapping technologies and ways to play their relative success, most of which will be in long established but reinventing blue chips. Disruption reflected in relative performance may well be driven more from within incumbent sectors (reflected in rising return dispersion) than from outside them.
WalMart has rallied strongly in recent months versus Amazon and GM versus Tesla as both start benefiting from the underestimated ‘second mover’ advantages of allying scale economies with new business models and technologies. GM or GE were not first movers in diesel locomotive engines in the 1930/40s but by rapidly buying up promising start-ups and harnessing them to vast engineering and balance sheet resources ended up dominating the transition from steam over the subsequent two decades, crushing smaller ‘first mover’ competitors along the way.
The parallels with GM’s pivotal Cruise Automation acquisition and Chevy Bolt platform being rolled out via Lyft are worth watching closely (with Ford attempting a similar reinvention) as are WalMart’s belated e-commerce shift via the Jet.com acquisition. The breathless Silicon Valley hype is ignoring a looming period of accelerated evolution within sectors that will radically change their leadership and where spotting the sector Dodos unable to rapidly evolve within a portfolio is critical.
As an example, being a value investor in tech is generally a losing proposition but Intel which in terms of chip sector evolution has become a ‘second mover’ by missing the GPU versus CPU shift has been racing to integrate a series of strategic acquisitions (notably Mobileye in autos and Nervana in AI chip design) to play catch up in this market – if it succeeds against low expectations, the huge valuation discount to the perceived AI market leaders will close and versus AMD relative performance has now turned decisively. Tech disruption won’t be the much feared extinction event for adaptable incumbents – the quality of management will be key alongside aggressive M&A to preempt new entrant threats, but there are growing signs that hugely rated tech insurgents are not going to have it all their own way for much longer. Therein lies the investment opportunity…