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How megatrends can help fuel growth in an economic recovery

Is there potential to exceed benchmarks if companies focus on digital transformation, healthcare innovation and sustainability?


Is there potential to exceed benchmarks if companies focus on digital transformation, healthcare innovation and sustainability?

Market analysts generally agree that three major megatrends sweeping the globe—digital transformation, healthcare innovation and sustainability—are going to fuel high growth rates in those companies that successfully take advantage of these developments.

Already, companies are delivering against these earnings growth expectations. But we take it a step further: we think that megatrend beneficiaries may not only continue to outperform slower-growing counterparts but also may do even better than current consensus projections.

 

Our major findings

Generally, we believe that today’s earnings estimates do not yet capture the additional upside we think is likely to come from these new investment opportunities as new revenue streams go from concept to reality.

More specifically, we think investors are underestimating the potential in:

  • Technology—the value of the new revenue streams that 5G and artificial intelligence (AI) are offering. Already, we see evidence that COVID-19 is accelerating adoption of key technologies, such as cloud computing and, with it, cloud security and AI. Currently, Nasdaq Computer Index 2019⁠–⁠2022 earnings growth is forecast at approximately 10%. But we believe that neither 5G’s $700 billion revenue opportunity nor AI’s $16 trillion opportunity that are likely to begin to materialize in the next five years are priced into stock values—yet.
  • Healthcare—the confluence of data and gene-based technologies, as well as a recent pick-up in biotech R&D, that may speed up new molecule approvals and therefore may help increase earnings growth. While innovation in healthcare is not new, today’s speed is. We expect the increasing pace of new treatment approvals in the next five years could yield $255 billion of additional revenues by 2024. If half of that accrues to biotech companies, the revenues of Nasdaq Biotech could almost double from current levels. So, while consensus projections see a 27% earnings growth rate for healthcare, we expect greater growth because, typically, analysts do not recognize the full value of future sales until they are a reality.
  • Sustainability—the speed of the move toward sustainable economies, which is increasingly dictated by favorable economics. Clean energy earnings are projected to grow 17% from 2019–⁠2022. But, much like digital transformation and AI, the move to sustainable investments is still very early in its life cycle. And while the immense opportunity has been well-telegraphed, a historical look at forecasts reveals consistent underestimations of both capacity build and generation.

 

What drives outperformance?

We find that the most significant factor driving outperformance versus benchmark is a sector’s expected earnings growth rate. It was the sectors and stocks with higher expected growth rates that outperformed over the past 20 years, despite valuation fluctuations and earnings revisions.

For example, since 2001, technology and biotech (the S&P 500 sectors responsible for a large portion of innovation and whose earnings growth rates outpaced the index) have cumulatively outperformed the SPX by 103% and 357%, respectively.1

Tech and biotech have cumulatively (though not always consistently) outperformed over the past two decades

The bar chart shows a comparison of the average annual performance over a variety of time periods in the past two decades for SPX, tech, and biotech. The chart shows that tech and biotech have cumulatively outperformed the SPX over the past two decades, although they have not outperformed in every time frame.

 

Another determining factor appears to be how much investors are willing to pay (in multiples) for expectations of growth in earnings. When the willingness fluctuates, it can detract from performance. Still, the most significant factor driving outperformance was a high starting point for earnings. So it pays to look at those sectors, subsectors and companies that have high growth rates. What we find: the earnings growth for tech, biotech and clean energy indices is projected to run at a double-digit pace, well ahead of the S&P 500. See below.

 

Expectations are high for tech, biotech and clean energy

The bar chart shows the 2019-2022 EPS CAGR for the SPX, Nasdaq Computer, Global Clean Energy, and Nasdaq Biotech. The SPX has the lowest EPS CAGR for this time frame, showing that expecations are high for tech, biotech, and clean energy.

 

How do you find potential winners?

Given our high performance expectations, how do we propose identifying investments that could benefit from the megatrends? We see three paths:

  1. Sector—Identify emerging trends within each sector likely to have earnings growth rates that are above the average
  2. Company—Analyze companies’ fundamentals and growth drivers to select those likely to surprise to the upside
  3. Private opportunity—Invest in largely undiscovered private companies before they go public and become widely recognized

It will take a lot of research, analysis and monitoring to stay on top of the global megatrends and spot the right companies. We invite you to speak with your J. P. Morgan team to hear our latest insights into opportunities and how megatrends investing might fit into your overall wealth plan.

1. From 2001 to 2005 the average annual performance of tech trailed the SPX. Yet tech has been a consistent outperformer since 2006. In particular, it has substantially widened its outperformance since 2016. Biotech’s track record has been spottier. While it outperformed on average, a lot of that outperformance occurred from 2011 to 2015. Since 2016, its average returns have been lackluster.

 

 

 

 

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All market and economic data is as of May 2020 and sourced from Bloomberg Finance L.P. or Factset unless otherwise stated.

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INDEX DEFINITIONS

The NASDAQ Computer Index contains securities of NASDAQ-listed companies classified according to the Industry Classification Benchmark as Technology excluding Telecommunications Equipment. They include computer services, internet, software, computer hardware, electronic office equipment, and semiconductors.

The NASDAQ Biotechnology Index is designed to track the performance of a set of securities listed on The Nasdaq Stock Market that are classified as either biotechnology or pharmaceutical according to the Industry Classification Benchmark (ICB).

The SPX (S&P 500 Index or the Standard & Poor's 500 Index) is a market-capitalization-weighted index of the 500 largest U.S. publicly traded companies.

The S&P 500® Information Technology comprises those companies included in the S&P 500 that are classified as members of the GICS® information technology sector.

The S&P 500 Biotechnology and Industry Index comprises stocks in the S&P Total Market Index that are classified in the GICS biotechnology sub-industry.

The iShares Global Clean Energy ETF seeks to track the S&P Global Clean Energy Index.

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