For those looking for reasons to be pessimistic about the out-look for global equities, there are plenty out there at the present. Among the most talked about is the recent surge in global oil prices due to instability in North Africa and the Middle East.
The potential negative consequences of this, including demand erosion and inflationary effects, are well known and probably quite well priced in too. However, higher oil prices, and commodity prices more generally, can also have some positive side-effects such as spurring greater innovation. Generally, I feel markets may be somewhat less adept at taking account of this area.
History shows that technological leaps often follow periods of geopolitical or financial disruption, with the oil price shocks of the 1970s contributing to the personal computer boom and the Asian crisis in the late 1990s preceding the internet and smartphone developments of the past decade. In today’s context, I believe high comm-odity prices can be the catalyst for renewed innovation, partly out of necessity to combat rising costs and partly as a consequence of new technologies becoming commercially viable for the first time as a result of the new pricing paradigm.
Innovation will also be driven by the shift in China’s economy from an investment-driven to a more consumer/ service-led model. China’s policymakers remain focused on driving this shift, given the demographic challenges that the country faces in the next 15 years as a result of its one-child policy. Until now, Japan and the US have been the leading issuers of patents but I expect China to challenge their pre-eminence, especially as its growing affluence and abundance of opportunities encourages ethnic Chinese residing in the US, for exam-ple, to relocate back home.
People who have worked abroad at firms such as General Electric and Siemens will bring with them a wholly different mindset to that still prevalent in the big government-owned corporations in China. A more innovative mindset in combination with a highly educated workforce will prove to be a potent mixture.
Having already largely put in place the physical infrastructure it needs, China will also demand a new generation of software and other technologies. This is another logical progression from the commodity boom we have experienced. If you look at the quality of infrastructure in China, it is miles better than anything we see in the rest of the emerging world.
In a globalised economy, an exciting aspect of these new waves of innovation is the fact that some of the beneficiaries will be domestic companies and some will be overseas businesses. Among the latter, beneficiaries of this trend range from multinationals such as SAP and IBM, which have the technologies, to the luxury consumer goods companies such as LVMH, Richemont, PPR, BMW and Daimler, which have the brands that the emerging consumers aspire for.
Luckily, from a global investor’s point of view, the distinction is immaterial. Hence, my investment work remains focused on finding the companies operating at the most interesting parts of the value chain, where the pricing power is greatest and most sustainable.
Critically, when evaluating businesses, this is about more than just the ability to put up prices. It is also to do with the power of brand and the ability to demonstrate market-leading, low-cost manufacturing capability. Pricing power in technology, for example, lies with the companies that can innovate and bring down prices as this increases affordability and expands the addressable market.
At a time of significant concern about the macro-economic and geopolitical outlook, this may seem an overly optimistic view of the future but previous periods of innovative progress have also emerged from similarly unpromising backdrops.
Amit Lodha is manager of the Fidelity global industrials fund