Tech is the New Macro

Tech is the New Macro

We have entered a new Digital Age where the rapid expansion and implementation of technological innovation has become a key factor in the behavior of the economy and capital markets. This new era is marked by the transition from “atoms” to “bits,” resulting in a capital-light economy in which technology is being substituted for labor and physical assets. Fueling this transformation is data, an imperative resource and what we have labeled as the “new oil.” We have written extensively on this topic and the implications for business and investors in the years to come.

“What is your business strategy in the digital age?” has become one of our favorite questions to ask management teams.
If a company cannot provide a convincing response, we believe it will likely flounder and ultimately disappear.
– William Priest, Executive Chairman, Co-CIO and Portfolio Manager

Presentation – November 2, 2021   White Paper – September 21, 2021  
From ‘Atoms’ to ‘Bits’ –
Turbo-Charging the Digital Economy		   The Pandemic Accelerant Part II:
Turbo-Charging the Digital Economy		  
   
Epoch’s Global Strategist, Kevin Hebner, talks about the pandemic and its acceleration of the digital economy. He also presents China’s changing regulatory environment, the impact of “common prosperity” on equity markets and our outlook on inflation. The recent surge in start-ups and unicorns reflects the broadening of the digital revolution across industries, and suggests improving productivity and free cash flow. Further, although the digitization of the economy is still in early earnings, we expect digital platforms to represent the majority of market cap by 2025, with tech, health care and communications the most promising sectors.  
       
Insight – March 24, 2021   Insight – February 11, 2021  
Money 3.0: Central Bank Digital Currencies (CBDC)   Moore’s Law & the Race for the Rest of the Chessboard  
   
During the past two years, CBDC has progressed from a bold speculative concept to a seeming inevitability and core feature of our financial ecosystem. This paper explores the potential disintermediation of significant swaths of the commercial banking system.   Both sides of the political spectrum are pushing for regulatory action of Big Tech. We explain why tech will continue to be the most dynamic sector of the economy, and why we expect greater breadth in tech market leadership.  
       
White Paper – January 22, 2021   White Paper – August 19, 2020  
Will Biden Take On the Tech Barons?   The Pandemic Accelerant: Digital Age Business Strategies  
   
The Cambrian explosion of exciting breakthroughs in AI, autonomous driving, 5G, and cloud computing will drive double-digit growth in semiconductor revenues for the foreseeable future. We have a constructive view on the semiconductor sector and believe it possesses considerable upside.   The last six months have been profoundly transformational, with the COVID shock acting as an accelerant for the digitization of the economy.  
       
White Paper – January 31, 2018   White Paper – June 19, 2019  
When “Bits” Meet “Atoms” Blitzscale and Hope: Unicorns, IPOs And The Fear of Repeating the Late 1990s  
 
The Digital Age and the transition from “atoms” to “bits” implies a capital-light economy in which technology is being substituted for labor and physical assets. Its impact is widespread and stretches beyond the technology sector.    The current hype about two-sided digital platforms, blitzscaling and winner-takes-most markets has fueled a surge in IPO listings and produced stratospheric valuations that are difficult to reconcile with free-cash-flow (FCF) fundamentals.   
     
White Paper – August 10, 2017   Insight – December 10, 2018  
Tech is the New Macro – Part II: Implications For Labor Markets And Productivity Trump, Tech and Trade
   

The rapid expansion and implementation of technological innovation has become a key factor in the behavior of the economy and capital markets. In this paper we explore how platforms and their network effects have resulted in a winner-takes-all market.

   China’s mercantilist behavior, underscored by its “Made in China 2025 initiative,” is in conflict with U.S. demands for greater IP protection, a level playing field and improved market access. Left unresolved, free trade and globalization will be in retreat.  
       
White Paper – June 29, 2017   Insight – September 13, 2018  
Tech is the New Macro – Part I: Impacting All Three Components of Return on Equity Is e-Commerce a Bubble?
   
The rapid expansion and implementation of technological innovation has become a key factor in the behavior of the economy and capital markets.   While the e-Commerce index as a whole appears frothy, many companies in the sector do possess sound and promising business models. For investors, the key to success is understanding how these business models should be valued.  
       

Our Perspectives

In this second part of our two-part series, we demonstrate that deglobalization implies trend increases in capex and the labor share, as well as a higher weighted average cost of capital (WACC). This constitutes a secular headwind for margins and free cash flow (FCF), especially for tech and manufacturing. With companies facing greater macro volatility and an elevated WACC, we expect lower average multiples. This will prove especially challenging for longer duration assets, such as venture capital and speculative tech companies that are years away from generating FCF on a sustainable basis.

Global supply chains are being overhauled to reduce vulnerabilities and to restrict Chinese imports of “dual-use” products that can be used for both commercial and military purposes. In Part I of this two part series we show why the initial focus is on semiconductors and energy, and where it might go from there (AI, quantum computing, and other advanced tech). We also demonstrate the challenges for Chinese equities and U.S.-based multinational corporations, which have been the two biggest beneficiaries of globalization.

Of late, people are blaming a variety of economic ills on an unlikely villain: the desire of investors to earn good returns on capital. But, no industry can be expected to survive if it is not creating value for the investors in that industry. Earning good returns on capital is not an obstacle to satisfying consumer demands; it’s what enables companies to continue to satisfy those demands.

Until recently, we had been living in a disinflationary environment that started in the 1980s. We believe three factors – Deglobalization, Demographics and Decarbonization – have led us to a secular reflationary environment. As a result the next decade is going to look quite different than the 2010s, with a number of critical implications for investors.

The transition to net-zero emissions (NZE) involves a fundamental change in the structure of the economy, and will likely be messy, implying periodic supply shortages and even more volatile energy prices. Further, inflation and nominal interest rates will probably be higher and more volatile, especially relative to the levels of the last two decades. This has not yet been priced into markets.

The recent surge in start-ups and unicorns reflects the broadening of the digital revolution across industries, and suggests improving productivity and free cash flow. Further, although the digitization of the economy is still in early earnings, we expect digital platforms to represent the majority of market cap by 2025, with tech, health care and communications the most promising sectors.