Surprise, state aid will govern the markets

What is not said about the real dynamics that underlie the markets, including the financial ones. The analysis of Alessandro Fugnoli, Chief Strategist of the Kairos Funds

Innovation, especially if it is revolutionary and disruptive (disruption), is a concept that many investors find irresistible. To stay long in disruption is to marry a philosophy of history, that is, to be on the side of modernity and its magnificent and progressive destinies. The most radical singers in this vision go beyond Belle Époque’s optimism and live in the messianic expectation of what the visionary von Neumann called Singularity, the moment when technological growth will become uncontrollable because it will be controlled autonomously by artificial intelligence and from machines.

If you go back in time, after all, would you like to have in your portfolio, by the beginning of the nineteenth and twentieth centuries, the titles of companies that produce wagons, buggies and landau or car manufacturers?

And yet the creative destruction of capitalism not only consumes the old, but consumes, like all revolutions, often also its children, or the mouthpieces of the new. Most car manufacturers from the early twentieth century went bankrupt almost immediately. A century later, in 2009, almost all of the few remaining producers found themselves on the brink of bankruptcy, and the Obama administration had to allocate $ 85 billion to save them.

And the wagon manufacturers? They are still there and those who are left are enjoying good health and a growing market. The Amish, the radical Anabaptists who reject the distractions of modernity and move only by chariot or concert, numbered 177,000 in 2000 and are today more than 370,000. And today’s carriages are comfortable and have disc brakes.

Yes, that is to say, but now there are electric cars. Well, the first electric wagon dates back to 1832, while American newspapers from 1899 host ads for the Baker electric car. Quiet and clean, the message sounds, it is equipped with a battery that gives it 70-100 miles range and you learn to drive it in 20 minutes. On April 29, 1899, the electric Cita 25 sets the world speed record and reaches 105 kilometers per hour.

After this magnificent false start, the electrical almost disappears. More than a century will pass limited to the modest niche of trolley buses and stock wagons. Sure, in thirty years he will dominate the world, but after a twisted journey and a near-death experience.

In light of the electric car’s triumph and the universal use of batteries for energy conversion, the markets have pushed up cobalt, lithium and nickel. One tonne of lithium, traded in 2020 at an average price of $ 8,000, reached $ 21,000 last year and $ 60,000 this year. With demand growing at 30 percent a year, many investors have thought that lithium is a choice to make with closed eyes.

What has happened, however, is that in one of the very rare cases of supply elasticity that we have seen in this new supercycle of inflated demand and blocked supply, lithium production is growing more than the needs of industry. Goldman Sachs therefore sees a sharp decline in the coming months and assumes a price of 16 thousand in 2023.

On the other hand, the old fossil energies, abandoned to death, are experiencing a new youth as a result of robust demand and a blocked supply. The German Greens accept that if Russia interrupts the gas supply, coal will be used again.

Fossil energy is part of the general awakening of old industries and their rediscovery of the market. However, the energy dynamics are special. Even more interesting are other traditional sectors, especially industrial ones, almost forgotten in these years of technology and the triumph of growth.

These sectors have had to eat dust for twenty years. Chinese competition, ever tighter environmental regulation, high cost of capital due to the compressed multiples and less evasive taxation, which for the technology giants have produced a fierce natural selection, leaving very few items alive in every ecological niche.

A study published in recent days by the Boston Fed (Cost-Price Relationships in a Concentrated Economy) is very informative in this regard. The concentration of American industry continues to rise. The Herfindahl-Hirschman index, which measures (attributed to the square of the market share of individual companies) has grown by 50 percent from 2000 to today. According to the study’s calculations, this increase in the concentration allows surviving companies to pass on 25 percent more of the increases in the cost of components and raw materials to their customers.

In other words, many traditional sectors today have a pricing power, in times of galloping inflation, no less than that of technology semimonopolies. Good margins, controlled costs, constant growth, high pricing power and very low multiples make them particularly attractive in a challenging time for the global economy and financial markets.

It is clear that disruption will continue to have an important place in the hearts of investors. However, it must be borne in mind that innovation in the next historical phase will be primarily driven by investment or government subsidies. This will make growth in the affected sectors (semiconductors, renewable energy, digitalisation) more secure, but margins are more uncertain. Equity portfolios will therefore need to maintain a balance sheet, preserve the best of what the last decade left us as a legacy, and look for the opportunities that the last decade neglected.

When it comes to markets, the ongoing recovery is due to the overlay of a new paradigm on what had guided the decline. The idea that dominated the bear market was a stagflation that could turn into a recession if central banks decide to fight inflation at any cost (as they say they want).

The paradigm of the ongoing recovery looks, instead of a rather gloomy near future, at a present that maintains important growth areas (especially in services) and at a longer future where inflation will have returned to acceptable levels thanks to a monetary slowdown. , already discounted in market prices.

Since it is very early to determine which of the two paradigms best reflects the underlying reality (although the latter seems more balanced), it is likely that we will see them coexist and alternately in command for the rest of this year. In the immediate future, once the ongoing correction of the excesses of pessimism is complete, markets can legally stop and wait until September with the Fed. the situation.

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