Ceri Jones runs through the bull and bear points for specialist fund areas for the year ahead.
It has been a tough year for most specialist sectors, which have been hit by rising interest rates, the war in Ukraine and slowing economic growth, particularly in China, owing to its zero-tolerance Covid policy.
However, there are signs that inflation is starting to peak in some areas, helped by a mild winter and lower gas prices, and that President Xi Jinping has reopened China.
Below, we run through the tailwinds and headwinds for four key specialist areas: technology, healthcare, biotech, and commodities.
In the technology sector, the biggest stocks (Alphabet (NASDAQ:GOOGL), Microsoft (NASDAQ:MSFT), Meta Platforms (NASDAQ:META), Netflix (NASDAQ:NFLX), Tesla (NASDAQ:TSLA), Amazon (NASDAQ:AMZN) and Apple (NASDAQ:AAPL)) have lost $3 trillion (£2.4 trillion) in market cap over the last year, and responded to falling demand and advertising revenues by cutting costs and laying off staff.
Technology suffers when interest rates rise because investors put a lower value on companies whose future earnings are weighted out into the future. The lockdown in China has also had an impact as it is home to a massive and relatively young consumer market, outnumbering American under-40s by five to one. Inflation is also a key concern in this sector as companies need certainty to be able to plan their budget spend on tech.
However, recently, with every hint that the interest rate cycle has reached its high and central banks are a little less hawkish, some investors have hastened back to the sector, largely in the belief that technology is now embedded in modern-day life, a secular trend that is unstoppable. In particular, big name investors such as Terry Smith and Warren Buffett have been buying tech and semiconductor stocks in the belief that valuations have fallen too sharply.
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Some of the most exciting developments will be in Augmented Reality (AR) and Virtual Reality (VR) that blur the physical and digital worlds.
“Venture capital investors provided about $4 billion in funding to AR/VR start-ups in 2021,” says Richard Lightbound, chief executive officer for EMEA & Asia at ROBO Global, a research and advisory company.
He notes: “This is ushering in new applications for many industries, which is expected to enable 20%-plus market growth per year, forming the foundation for a trillion-dollar market over the next 10 to 15 years. While adoption has been constrained by technological barriers such as the need for longer battery life, lighter-weight components, and better ergonomics, as well as a lack of maturity in the development process and supply chain, recent advancements are relegating these challenges to the past.”
NVIDIA Corp (NASDAQ:NVDA), Dassault Systemes SE (EURONEXT:DSY) and Autodesk Inc (NASDAQ:ADSK) are involved in AR/VR development and infrastructure, while Trimble Inc (NASDAQ:TRMB) and Faro Technologies Inc (NASDAQ:FARO) bring virtual and augmented reality to construction and manufacturing processes.
Mike Seidenberg, lead manager at Allianz Technology Trust (LSE:ATT), picks out cybersecurity as a sector able to do well in any climate as these services are heavily in demand across the commercial world.
He points out that 2.2 million cybersecurity jobs are currently open. Seidenberg also likes specialised semiconductors that help to reduce global emissions – such as those used in combustible cars to control LED lights.
The healthcare sector is different in that it is relatively insulated from the macro climate and should offer opportunities in any environment. Indeed, as investors digest the new levels of interest rates, they may look at healthcare stocks, especially in Europe, and recognise they are good value compared with other defensive names, such as utilities and consumer staples.
Demand is strong, given the increased prevalence of chronic diseases post-Covid, and the sector is highly innovative, not just within bio-pharmaceuticals, but within medical devices, medical technology and diagnostics.
“Healthcare is sometimes seen as ‘a sector for all seasons’,” says Ian Samson, multi-asset portfolio manager at Fidelity International. “We could see disappointing growth in other areas of the economy highlighting the secular growth potential of healthcare names in an ageing economy. The expected normalisation downwards in earnings after the pandemic may never materialise, and so profits could remain resilient,” he says.
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For James Douglas, co-manager of Polar Capital Global Healthcare (LSE:PCGH), consolidation is an additional opportunity. Douglas points out: “The industry is highly fragmented, generates strong cashflows and possesses healthy balance sheets.”
However, there are headwinds, such as the ‘patent cliff’. Regulation can also pose a problem, but a split Congress and the introduction of the Inflation Reduction Act has reduced the risk of healthcare reform in the US.
Samson also notes that Amazon’s entry into the healthcare sector could be aggressive, eating into the pricing power of competitors.
Biotech is advancing swiftly as our understanding of human biology increases, in areas such mRNA vaccines, and gene and cell therapy.
“Biology is at an inflection point; a convergence of technologies – including gene sequencing, biomedical imaging and machine learning – is making it possible to study biology at a scale that was unimaginable a short time ago,” says Rose Nguyen, portfolio manager of Baillie Gifford Health Innovation fund.
She says: “Now smaller biotech companies are starting to create therapies via a more rational, automated and industrialised process.
“Advances in gene sequencing illustrate how quickly things are moving. The cost of mapping out all the genes of a human being – known as the genome – was a little under $100 million in 2001. It’s since fallen to just $700.”
Genomic sequencing provider Illumina Inc (NASDAQ:ILMN) is well known for its role in delivering these savings.
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Meanwhile, 10x Genomics (NASDAQ:TXG) has developed machines that profile tens of thousands of individual cells in a single run, making it possible to compare healthy and diseased cells at scale to figure which genes cause a disease.
The convergence of genomics and AI technology also underscores the potential of liquid biopsy, a non-invasive approach to detecting cancer in the bloodstream at an early stage to optimise treatment. Illumina is acquiring GRAIL, a biotech company that has developed a test to detect multiple types of cancers through a single blood draw.
“Innovation in precision medicine, which looks at the genetics, environment, and lifestyle of a person to select the treatment that could work best for them, continues to advance and gain federal approvals,” says Lightbound.
He adds: “Using a companion diagnostics (CDx) liquid biopsy, physicians can now determine the most effective drug therapy on a patient-by-patient basis. For example, Guardant Health (NASDAQ:GH) received additional FDA clearance in August 2022 for its liquid biopsy test. The test supports drug selection for non-small cell lung cancer, which accounts for around 82% of cancer deaths worldwide.”
The direction of commodity prices is closely associated with economic growth. Recently prices for oil, and base and industrial metals, have risen with every sign that President Xi Jinping is serious about reopening China. The People’s Republic accounted for 16% of global oil consumption in 2021.
“Oil prices will also be boosted by constrained supply, with OPEC actively looking to defend the price, while tougher environmental regulations under Democrats in the US remove the possibility of a substantial supply response,” says Dorian Carrell, a multi-asset fund manager at Schroders.
He adds: “The limited supply in iron ore and aluminium will also push prices higher if there is rising demand from China, while the energy transition will likely lead to accelerated demand for copper in particular.”
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Conversely, “if global PMIs are weak and industrial production is rolling over, this would be ominous for metals demand,” says Zhoufei Shi, a tactical asset allocation analyst at Fidelity International.
He adds: “Specifically on energy, a cold winter is bullish for gas, while the end of SPR (Strategic Petroleum Reserve) releases and tighter sanctions on Russia and a consequent drop in Russian supply could cause oil to trade back towards $100.”
Interest rates and commodity prices have an inverse relationship, because the costs of holding inventory decreases in a low-interest-rate environment. Rising interest rates depress gold in particular.
Shi notes with the Federal Reserve hiking interest rates to, or beyond, 5% the case for gold is weakened versus cash or Treasury Inflation Protected Securities (TIPS), which provide decent nominal and real returns.
He, however, acknowledges: “There’s a slim chance that gold could do well if central banks pivot from rate hikes to a pause, or potential cuts. It is not likely, but not impossible if we have reached peak inflation.”
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