H2 2023 Thematic Outlook

In our January 2023 thematic outlook we reported how the result of discussion by BlackRock’s Thematic Research Investment Group saw macro resilience, supply chain resilience and climate resilience as important considerations for investors in 2023. Whilst there remains a degree of uncertainty in the near-term macro-economic outlook, there have been some notable developments that lead us to evolve our outlook for the second half of 2023.

Some of the powerful shifts we were seeing, such as the focus on climate related investment spend and supply chain reshoring, have continued to take hold, to the benefit of enabling companies and industries. There has been a focus on tackling carbon and energy intensive processes. We have witnessed a potentially breakthrough technology in the advances made in generative artificial intelligence (AI). When taking stock of the economic growth environment, central banks have raised interest rates as consumer price inflation remains above central bank targets in the US and Europe.

A multi theme approach may provide a diversified solution for thematic exposure.

Key themes the investment teams believe are going to drive markets through the remainder of 2023 and into 2024.

1. Supply chain – efficient reshoring

The need to build resilience into supply chains is supported by policies aimed at driving the reshoring of critical technologies.

2. Climate - investment in transition

We see a focus on clean power generation and clean transportation and evidence this is expanding to focus on decarbonising transition materials and supporting broader resource efficiency.

3. Opportunity in volatility

Inflation has proven sticky, whilst aging populations appear to be contributing towards tighter labour markets, even as economies see slower growth.

The views expressed herein are those of the BlackRock Thematic Research Investment Group. There is no guarantee that the expectations stated above will come to pass.

Supply chain – efficient reshoring

Investment in domestic production capabilities is being driven by two key factors, in our view. Covid highlighted the risks of disruption to extended supply chains, with significant costs to business, where there was insufficient resilience in product sourcing. Secondly, perceived increased geopolitical risks, particularly around a desire to foster domestic manufacturing capabilities in certain leading clean technologies. The US, Europe and China now have policies designed to support investment into domestic manufacturing capabilities for renewable power, electric vehicle batteries and semiconductors.

We believe that we are in the early stages of a major developed market industrial capex cycle, where companies may look to strengthen supply chains and bring manufacturing capabilities closer to home, supported by government policy. The US CHIPS and Sciences Act and the Inflation Reduction Act passed in 2022 included a focus on supporting domestic production, which is expected to have a meaningful impact on increasing investment in the US, see Figure 1. The European Union’s response was the Green Deal Industrial Plan, which looked to support domestic investment in clean energy technology.

For example, since the announcement of the US Inflation Reduction Act, over US$200billon of domestically focussed US investment has been announced.¹

A trend for energy efficiency related reshoring will play an important role as energy prices and labour costs remain higher, in our view. Europe has focused on low carbon policy for many years, yet it has not placed a focus on manufacturing the necessary technologies itself, but has frequently relied on manufacturing of the technology from China to bring solutions at lower cost. With the EU Green Industrial Plan, there is an apparent desire to have domestic production capabilities.

Figure 1: Cumulative investment mobilized on the back of the US Inflation Reduction Act, 2023-2032, totalling US$ 2.9 tn. 

Climate – investment in transition

2022 saw record 191GW installation of solar capacity² and the International Energy Agency (IEA) forecasts a further material increase in solar installations for 2023. The transition to a lower carbon economy is seeing large shifts in investment spending driven by policy support, a focus on energy security and advances in clean tech. We expect investment in clean tech to continue to outperform expectations.

Whilst the main focus on emissions to date has been about increasing clean power generation and clean transportation (electric vehicles), there appears greater recognition that a focus on power generation and transportation alone will not be sufficient to keep carbon emissions in line with the Paris Agreement. We believe it will be necessary to reduce waste and carbon emissions from the hard-to-abate sectors of manufacturing, steel, cement, water provision and agriculture and we are seeing companies invest in these areas, creating potential growth opportunities.

It will take an enormous amount of materials to move from the current energy system to a lower carbon world, as shown in Figure 2 and the (hard-to-abate) emissions from producing those materials will need to be addressed, in order to transition to a low-carbon economy. For some of these metals and materials, we think the transition is likely to drive structural increases in demand and given an expected slowdown in economic growth, we believe these areas could provide investors with interesting growth opportunities.

Figure 2: Mineral demand for clean energy technologies in IEA scenarios, December 2022

The Intergovernmental Panel on Climate Change (IPCC) published its 6th assessment report in March 2023, which summarised its current view on climate change, impacts and risks and climate change mitigation and adaptation. The report found evidence of observed changes in extremes such as heatwaves, heavy precipitation, droughts, and tropical cyclones. Mitigation pathways suggested by the report involved rapid and deep and, in most cases, immediate greenhouse gas emissions reductions in all sectors this decade. Policymakers are drafting legislation related to transition, Figure 3. As with any new policy, this may impact the relative competitive position of companies. The London School of Economics has identified over 2000 climate laws in 200 countries³.

Figure 3: Policies of many governments are supporting transition

Transition towards less carbon intensive manufacturing processes with end goods and materials recycled to be again used as inputs, can lead to significant advantages in terms of reliable sourcing, reduced energy input and consequently, lower emissions.

It is notable that the US and EU are pursuing policies in support of a hydrogen economy, which includes support for blue hydrogen in the US (with carbon capture and storage) and green hydrogen in Europe, to try to provide the means to decarbonise hard-to-abate industries.

Policymakers have begun to address issues such as waste and pollution through legislation in support of a circular economy, which has the aim to reduce waste and promote the efficient use of resources by keeping resources in use as long as possible. This involves greater recycling of materials, but also designing products to be reusable and recyclable.

Governments are building more policies in support of a circular economy with selected companies adopting, enabling and benefiting from these.

• One such policy is the EU commission’s ‘right to repair’ measure, announced this year, aimed at reducing e-waste by preventing repairable products from being prematurely junked and it agreed a ban on destruction of unsold textiles and footwear.
• In the US the Federal Trade Commission is set to update its Green Guide, which acts as a framework for companies to check environmental claims made in marketing, to focus on the circular economy.

Opportunity in volatility

In our 2023 outlook we observed that the US participation rate appeared to have dropped following the covid pandemic, but that this was likely partly a function of an aging population with more people reaching retirement. For central banks seeking to bring inflation towards a 2% target, this trade-off represents a challenge and may result in higher interest rates and lower economic growth, if tight labour markets persist and contribute to inflationary pressures. This can be seen in the pace of the rate tightening in Figure 4. Central banks may tighten conditions such that economic growth slows sufficiently in order to bring inflation down. BlackRock Investment Institute highlight this challenge with expectation for structurally tight policy bias to continue.

Figure 4: Fed rate hiking cycles, 1972- June 2023

As highlighted by the BlackRock Investment Institute, this new regime of higher macro and market volatility is quite different to the period of low inflation, low interest rates and low unemployment that has characterised recent decades. Many companies were able to raise prices over the past year to help offset rising energy and input costs. However, with weaker economic growth and lower demand, there may be greater differentiation between those companies with pricing power and those without.

Structural growth themes that persist though cycles of economic uncertainty may provide companies exposed to such trends with the ability to deliver earnings growth through a more challenging macro environment. Emerging technologies may also offer growth opportunities that are less correlated with the macro cycle. Generative AI may provide growth opportunities from solutions for many sectors such as banking, high tech, life sciences - the potential for health monitoring and drug discovery.

Read our technology H2 2023 outlook to find out more about generative AI

Aging populations appear to be contributing towards tighter labour markets, reducing the size of the workforce and the potential growth rate of economies. However, ageing populations may be structurally supportive for healthcare given the positive correlation between ageing population and healthcare spending. From med-tech to breakthrough Alzheimer’s treatments and weight loss treatment.

The last few years have been associated with La Niña weather events, bringing a cooling effect. Expectations are for the first El Niño event since 2015-16, potentially resulting in higher temperatures and variable rainfall, (Figure 5), which could impact crop quality in some countries and agricultural prices, adding volatility.

Figure 5: El Niño's potential impact on global weather, Jul-Sep 2023 forecast

A multi-theme approach

A multi-theme approach to thematic investing may focus on individual themes as building blocks that when combined together may provide clients with a diversified solution for thematic exposure.

When considering a multi-theme approach, a dynamic approach may be preferable in order that any individual thematic exposures may be tailored to the prevailing economic outlook. For example, when the outlook appears less certain, investors may wish to combine themes so as to reduce risk against a notional benchmark.

Increase Resource Efficiency: Rising food inflation and climate change is structurally shifting the approach to farming, while ongoing supply chain issues have been giving rise to new and efficient technologies. We believe that regulation around waste and recycling is increasingly leading companies to make their businesses more circular. Circular economy solutions aim to reduce waste and keep valuable materials in circulation.

Energy Independence and efficient reshoring: Energy independence has gained momentum amidst the ongoing disruption to European gas supply, increasing the attractiveness of lower cost renewable energy and energy efficient solutions. Policies are also increasingly focused on bringing manufacturing and production facilities for critical clean technologies closer to home, avoiding extended supply chains.

Living with the New Market Regime: A bias towards tighter monetary policy is a shift from recent decades. Given the ongoing market uncertainty around interest rates and resilience of economic growth, we believe investors may look to mitigate this through focusing on high conviction themes.

Risks to the base case

Macro economic policy

Our base case for the outlook includes assumptions around the likely path for inflation and interest rates, notably that inflation moves lower in 2023, but that it does not track back to pre-covid levels.

It may be necessary to adjust views based on the timeline that central banks act with regard to pausing interest increases as they seek to bring inflation down from high levels. The question may move to how long rates may be held steady before central banks eventually ease policy to support growth should data suggest inflation is under control.

Geopolitical risk

We have previously commented on the perceived increase in geopolitical risk, with the ongoing war in Ukraine and the US-China competition to lead in clean technology with protectionist policies announced.

Whilst there are a number of factors driving companies to build greater resilience in their operations and supply chains and direct investment towards the US or Europe to comply with the new sourcing rules, a reduction in geopolitical risk could see pressures for companies to act in the near-term lessen.

Source: BlackRock, allocations as of 31/05/2023. Portfolio allocations are subject to change and do not include any residual cash or currency forward positions used for currency hedging purposes.