Commentary: Navigating regime change — 3 thematic equity drivers for 2023

The year 2022 was one of market uncertainty due to lasting effects of the COVID-19 pandemic, rising inflation and geopolitical divide. All those triggered drastic sentiment swings, resulting in market rotations along factor, sector and country lines.

In 2023, the backdrop of higher inflation and slower growth will bring about even more volatile economic cycles in the decade ahead, driven by a multitude of factors including a still-rebounding supply chain and increased desire to onshore strategic sectors amid security concerns.

Allocators are at a crossroads of managing risk while generating returns in such a challenging market.

In this environment, adhering to a long-term mindset remains critical, as several secular trends will fundamentally restructure global markets and corporate success for decades to come. Our analysts have found that global equity thematic investing trends are, on average, only half as sensitive to economic cycles compared to global equity sectors.

Without the constraints of short-termism driven by the volatility of today's market, thematic equity investors can focus on thorough investment research, direct engagement with companies and agile active management — proven to be critical drivers of outperformance.

As we and other asset allocators enter 2023, we must take a step back to consider forward-looking structural trends affecting both industry leaders and their peers. Three themes we believe will weather the risk of an economic slowdown in 2023 are rapid digitization, aging demographics, and climate change and sustainability.

Global digitization has much further to go. The growth of enterprise data is increasing by around 40% annually, according to technology research firm Gartner Inc.

With new technologies such as the cloud and robotics, artificial intelligence and machine learning, the Internet of Things and fifth generation technology, businesses are racing to aggregate and integrate the software needed to pull ahead of the competition, and those who do well will reap the benefits.

Public-cloud expenditures as a percentage of total IT spending have risen significantly across every sector as enterprises seek third-party solutions for organizing and extracting data. In fact, worldwide public-cloud services end-user spending could reach nearly $600 billion by the end of 2023, up from $490.3 billion in 2022. With last year's correction in many next-generation software-as-a-service stocks, investors must consider the continued growth of data and the subsequent need to manage it more effectively. Given the substantial increase in public-cloud technology expenditures across sectors, companies now must transfer data stored in traditional forums to a similar architecture. We anticipate a multidecade market share opportunity for fully cloud-architected database vendors.

In recent decades, medical breakthroughs together with generally healthier lifestyles across much of the world have boosted average life expectancies into the 70s and even 80s in some countries. This has profoundly reshaped global demographics, as the share of the world population aged 65 years or older increased from 6% in 1990 to 9% in 2019. According to the Deloitte Center for Financial Services, that age group is projected to rise to 16% by 2050, with the developed world doing so at a faster pace than emerging markets.

The potential implications of this demographic shift will play a decisive part in return outcomes. One pocket of opportunity within modern health care, overlapping with the broader theme of digitization, is the onset of next-generation genome sequencing. There is a renewed emphasis on reducing cost while still allowing new modalities to prevent, diagnose and treat chronic illnesses — such as heart disease. Drivers of strong performance in the life sciences subsector will be those who consider both existing leaders in sequencing technology and advancements by next-generation companies.

Every sector must adapt to and mitigate the effects of climate change. To do so, public climate discourse and investors' priorities must consider a level of game-changing economic and corporate transformation that has not been seen since the Industrial Revolution. Considering the diversity and complexity of the challenge, markets may miscalculate both the risks and the opportunities, which may lead to exploitable asset price disconnects.

Environmental, social and governance integration strategies can be a powerful way for equity investors to address those price disconnects effectively.

These conditions create a tremendous opportunity in global technology, such as launching a better, more reliable power management tool in industries like semiconductors where power management is an essential component in electric vehicles, whose sales are trending upward.

However, the rate of adoption varies significantly by region and country — for instance, according to data from Alliance Bernstein, many European nations have dramatically outpaced their global counterparts, including the U.S., which does not even breach the top-15 list of EV sales.

Materials science advancements have driven the development of a new generation of silicon carbide-based semiconductors that enable continued efficiency gains for EV makers, likely leading to further cost reductions in the manufacture of EV systems in the long run. This could improve affordability for car buyers and fuel the trend of increased EV adoption.

With decarbonization and digitization themes also at play, environmentally friendly vehicles are anticipated to be a notable upcoming inflection point in global consumer demand.

Now is an exciting time of transition for asset allocators. Equity allocators must question many of the assumptions that have underpinned portfolio decision-making for the past two decades. Leveraging insights from global industry analysts to apply a thematic investing approach will be critical to weathering the risks of slowdown in 2023 and beyond.

Mary Pryshlak is senior managing director, partner and head of investment research at Wellington Management Co. She is based in Boston. This content represents the views of the author. It was submitted and edited under P&I guidelines but is not a product of P&I's editorial team.