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The Bid: “2024 Midyear Outlook: Waves of Transformation”

Episode Description:

Vivek Paul, UK Chief Investment Strategist for the BlackRock Investment Institute joins host Oscar Pulido to discuss the rise of AI and its potential to deliver a productivity boom, the role of private markets in infrastructure, and how geopolitical dynamics are influencing investment strategies, and ultimately answer the question of how investors can position themselves in this unprecedented era of change.

Written Disclosures

This content is for informational purposes only and is not an offer or a solicitation. Reliance upon information in this material is at the sole discretion of the listener.

For full disclosures go to Blackrock.com/corporate/compliance/bid-disclosures

TRANSCRIPT

<<THEME MUSIC>>

Oscar Pulido: The BlackRock Investment Institute recently published their 2024, Midyear Outlook where they consider the macro and market outlook for the remainder of the year. They highlight the potential for an economic transformation on par with past technological revolutions driven by five mega forces, three in particular, could drive a surge in investment in the coming years. The rise of AI, the low carbon transition, and the rewiring of supply chains. Yet this unfolds against a backdrop of high inflation rising interest rates and record government debt levels presenting a complex landscape for investors.

Welcome to The Bid, where we break down what's happening in the markets and explore the forces changing the economy and finance. I'm Oscar Pulido. Joining me is Vivek Paul, UK Chief Investment Strategist for the BlackRock Investment Institute.

We'll discuss the rise of AI and its potential to deliver a productivity boom, the role of private markets in infrastructure, how geopolitical dynamics are influencing investment strategies. And finally, how investors can position themselves in this unprecedented era of change.

Vivek, thank you so much for joining us on The Bid.

Vivek Paul: Thanks, Oscar, for having me.

Oscar Pulido: So, Vivek, I know that the BlackRock Investment Institute has recently published the mid-year outlook, and there are three major themes that, have been outlined. So perhaps you can tell us what those themes are and how you think they will play out.

Vivek Paul: Absolutely Oscar, so that this is a really exciting moment in investing right now because we are on the edge, potentially of some huge transformations when it comes to AI, when it comes to moving towards the low carbon economy, when it comes to geopolitical dynamics and mega forces that you and I have talked about in the past. And all of those are uncertain. This is an environment where plausibly a bunch of different scenarios could play out. So that's the background, that's the backdrop against which we have formulated these three themes.

And the first one is about getting real. It's about this idea that there is a transformation occurring when it comes to the real economy. And if you think back over the last 10, 15 years, a lot of it's to do with the financial economy. It's to do with the path of interest rates, seemingly ever lower or central banks coming to the rescue. What are they going to do next? This is an environment now where it's about the real economy. It's about incredible cash flows being generated by some companies because of some of the transformations that are occurring. It's about being able to spot the winners and the losers, which maybe be are even more outsized in their difference than before, because those who can really ride these transformational waves can have phenomenal returns. Those who can't, those that get left behind, don't have the safety net of those central banks in quite the way that they used to in the past. So, this idea of getting real is that first key theme, which I think really sets the scene. The second one is about leaning into risk, and that's really important because I mentioned the idea that the potential future outcomes can be very different and there could be a bit of a temptation to sit on the sidelines and wait to see what plays out. That's not what we think we should be doing right now. We think we should be leaning deliberately into risk. Being deliberate about time horizons. What do we know? Even if the future's uncertain, there are things that we know about the coming six to 12 months. We lean into the idea of a concentrated AI scenario where we see some benefits from some of those big names who have done really well. We think that can continue and, potentially because of the idea of a productivity boom later on, we can continue to have a lot of interest from investors in terms of some of those key names. So, the idea of leaning into risk in terms of time horizon in terms of the type of exposures we're talking about.

So, we have been playing this environment in a deliberately concentrated manner. So even though some of those core indices are really concentrated now, we'd be even more concentrated still because that's where some of the opportunities are. And then being really deliberate when it comes to the idea of where the opportunities are across public and private market assets and the type of exposure we want to get. So, this is an environment which rewards being a little bit more dynamic and active in terms of getting some of those exposures. So, this is, again, another thing that we need to lean into that risk.

And the final point, I guess the final, the third theme is this idea of spotting the next wave. And this is all to do with those scenarios I was talking about at the start. There could be a bunch of really materially different world outcomes that could occur and being understanding, you know what they are.

What are the catalysts? When do we need to shift portfolios? That really could be a huge source of future potential benefit. We need to be able to potentially transform our portfolios depending upon what we learn over the course of the coming months and the coming years. So that idea of leaning into those scenarios, not just being afraid of sitting on the sidelines, leaning into risk, and getting real, they are the three themes that we think really matter today.

Oscar Pulido: Now, you didn't mention AI, but you did talk about the real economy, which leads me to believe that maybe that's where we can start and maybe talk about AI within that first theme because this is a trend that over the past year and a half has really capture a lot of headlines and companies that are associated with AI are seeing their stock market valuations surge. Perhaps the question is, do you see the potential for AI to continue to bring on these productivity gains that the market seems to indicate are happening?

Vivek Paul: So, I think the real key point here is that firstly, this AI transformation is a real thing. This is happening now; we're seeing outsized earnings already. So, this is not just something that could happen in the future, this is transforming the real economy now. But I think. A really key point is that there is uncertainty. We need to acknowledge this, so there is a world out there, as you suggest, where there are real broad productivity gains across the entire economy, and maybe that has transformational impacts on. The idea is that's the reason why growth is higher relative to what we've seen in the past. It might be a reason why inflation is lower relative to what we've seen in recent years. So that is a possibility, but it's not a certainty. And I think that is really crucial right now. So, the point is that could occur and the fact that could occur is part of the reason why we are seeing such phenomenal performance from some key names, in the course of the last 12 to 18 months, as you suggested Oscar.

And in terms of where we are right now, we would lean into the notion of that for the next six to 12 months. This concentrated AI story really could continue that we could really continue to see some outsized performance by some key names, and whether or not that then broadens out into broad productivity again, is a possibility. But it's not a certainty. The fact though, that it's a possibility is part of the reason why we have that conviction over the next six to 12 months.

And I just want to pick up on something you said with regards to, the amount of outperformance and the size of those valuations. We wouldn't see this as bubble territory now. This is an environment where the earnings have kept pace with those fantastic gains in stock prices for many of those big names. So, this is an environment where earnings have delivered, that means we're not in a bubble, that means we continue to see a strong runway for some of these companies ahead. And there is that possibility that it broadens out across the overall or the overall economy.

Oscar Pulido: Right. So, what you're saying is that a lot of these AI names, these companies have seen their stock prices go up a lot, but so have their earnings. So, the valuations are, still very reasonable and it's still a theme that you're recommending within portfolios.

Vivek Paul: So, Vivek, what are some of the implications of the advancement of AI on investor portfolios and perhaps thinking outside of technology, are there ways to invest in the theme of AI in a more diversified manner as well?

It's a great question, and I think when you're thinking about AI, one of the things we talk about in the outlook is the idea that there are going to be some distinct phases when it comes to the AI investment opportunity set. There's going to be this build out phase, but then the idea of the expansionary phase where it potentially goes beyond just the names who have benefited so far. I think it's exactly what you're talking about, Oscar. I think there are potentially future huge implications for the likes of healthcare, for the likes of financials. This is stuff that goes beyond just a few limited names.

More broadly, when you're thinking about a potentially transformative impact like AI, you need to be thinking about the potential, the stack of where the opportunities might lie. So, if you imagine, thus far it's really been those names who have been able to provide the sort of hardware sort of solutions, the idea of chips that are needed in order to see that sort of spurt of activity. But what about the next phase? What about the next phase when it comes to the software, what, when it comes to the apps that we're going to all have on our devices, on our phones, and that can be transformative across a whole number of different sectors.

This is part of the point that we were making earlier when we were talking about the idea that there could be a productivity boom, it could have economy wide effects, and that's something that will be priced into market sooner than we actually fundamentally see those things transpire.

Oscar Pulido: So, Vivek, when we talk about AI, I think we all believe it to be this big productivity enhancer over the long term, and I, think you would agree we're going there. But in the near term, and I know this was discussed in the mid-year outlook, is that it could actually be inflationary in the near term because there's just so much infrastructure that you need to build out in order to support it. In fact, Will Su who we recently had on the podcast, from our fundamental equities team talked about just the raw demand for energy that is required. So, can you elaborate on that a little bit more?

Vivek Paul: I think it's a great point, and I think that is something that really, as we are learning more about what this could be, I think it's something that's coming to the forefront of our minds. So, I agree with the point that, the conventional narrative has been that eventually that could be this huge productivity benefit, which maybe is a deflationary force, but in order to get there. We need to see spending; we need to see real money being put to work. And if historical guys are anything to go by, there is a lag between spending that money and then seeing those productivity benefits come through.

So that means that in the nearer, maybe this is actually an inflationary force before it is deflationary to the point you made. And I think, that could work in just the lagged effect way that I talked about, but also imagine bottlenecks that could occur, the amount of power that we might need to kind of service.

This huge transformation might mean that maybe the areas where actually there are bottlenecks that occur in terms of those data centers, the ability to produce the amount of energy that we need and that could contribute to, to contribute to those inflationary forces too.

Oscar Pulido: So, AI as a theme seems to be, at least in today's markets concentrated to a few names, but what you're saying is that going forward, there could be a lot of different ways and a lot more diversified ways to invest in this theme across sectors and geographies. Vivek, we recently spoke to David Giordano, on the importance of infrastructure in helping the world economy in the low carbon transition. He also talked about the role that private capital will play in helping fund this infrastructure. You talked a little bit about private markets in, one of your opening comments, but how should investors be thinking about private markets in their portfolios?

Vivek Paul: Private markets are crucial to understanding the opportunities here, and you can think about the opportunities in the private markets, maybe as an advanced preview of the huge companies that could enter the public markets later on. Maybe they don't, maybe they do, but to limit ourselves only to the public markets, to capture some of these transformations, I think would be missing a trick.

We would explicitly lean into private market assets. When we build portfolios over the long run, we typically have a sizable allocation to private assets. And within the growth private market space, we particularly like infrastructure opportunities. They cut across several mega forces that are, playing out across the broader economy. You mentioned, I think the transition, the amount of energy that is going to be driven from renewable sources is likely to go up over the course of the coming years, is something that is central to our transition scenario that we have that is going to need a lot of infrastructure spending.

The idea of demographics. Demographic headwinds and tailwinds exist across the globe, and typically we find, and we write about this in the outlook, that as those demographics, point in a certain direction, you end up seeing more need for infrastructure in those regions. And another mega force that we've been talking about, the idea of geopolitical dynamics, the idea of reshoring dynamics that are going on. Again, that's going to lead to the need for infrastructure spending. And this is all against a backdrop where many developed market economies don't necessarily have a huge amount of headwind for governments to fund some of that infrastructure need.

So there's a real opportunity here for private capital to play a role in reshaping the future economy. So, the headline answer to your question is, if we only limit ourselves to the public markets, there are great opportunities there, but we are not seeing the full picture and I believe in the portfolios we design, we'd have a greater allocation to private assets that many see is typical.

Oscar Pulido: And as you talked about, private markets, you actually, you mentioned mega forces and we've talked about ai, which is one of the mega forces that the BlackRock Investment Institute has highlighted. you talked about demographics. you also talked about the transition to a low carbon economy. Let's talk about geopolitical fragmentation. Which is another one of these mega forces, and it is causing a rewiring of supply chains around the world. So, what does that mean for investors when we see this rewiring of supply chains that's going on globally?

Vivek Paul: So, I think it means that we need to be a little bit more granular in terms of the opportunity set that we are going to lean into,

For instance, we look at the US and China, we look at the EU and China, and there is a structural dynamic that exists that didn't exist before. This is an environment whereby the typical supply chains we came to rely upon for so long are being questioned because of reasons to do with national security to do with competition, you name it. That's happening. So, what's happening is the economy is dealing with that. Supply chains are rewiring, and you look at countries such as India, such as Mexico, who stand to benefit from being a node in the middle between two of those great superpowers to actually profit from the ability to sell into local markets, between the US and China. So, there are some geographical dynamics that directly occur as a result of this. And this is part of the broader thinking around geopolitical tensions and dynamics.

And more broadly, if you think about this and the influence over geopolitical dynamics on the broader macro, this is a force that kind of contributes to inflationary pressures. This is part of the reason why many of the scenarios we have, have interest rates a little bit higher than we've been used to. This occurs at a macro wide level. This has an impact there. It also means that there are particular opportunities we can lean into at a regional and geographical level as well.

Oscar Pulido: Right, on that last point, the reason it has implications for interest rates and inflation is that reshoring has been this trend that, means companies are a little less focused on putting their production in the lowest cost location and perhaps putting their production in a, more, politically friendly and perhaps closer geographical, location. And that can have inflationary. consequences though to the end goods that they produce.

The other, topic when we talk about geopolitics that we have to discuss this year is elections. It's one of the biggest election years on record in terms of the number of countries that have elections. We've already seen this year, Mexico, France, India, the UK, where you are, Vivek, and of course we have the US election later this year. So, how are investors preparing for the potential policy shifts that come when we see changes in government.

Vivek Paul: The first point is that some of these policy shifts that could occur are really sizable, right? And that this contributes to this environment of huge uncertainties, contributes to this world where there are multiple different potential ending zones for the way in which the global economy looks.

And just taking a couple of those, examples. we are recording this Oscar in the week where we've just had the UK election. We've just had the second round of the France selections, and these are big, sizable moves and they have potentially really meaningful impacts in terms of the policy here domestically, but also more broadly globally.

But what's interesting, I think when we're thinking about these policy shifts, is as much as what is not being said, as is what is being said. I'm coming come back to the point we were making earlier when we were talking about the geopolitical dynamics, the potential impact on inflation, some of the policies that are being touted in the American election, lead to potentially really meaningful inflationary pressures if some of the tariffs that are being talked about actually were enacted.

Now that is sizable and that is in the public domain, and that's being debated, but what's not really being debated, particularly in the United States, is the fiscal dynamic. The fiscal pressures, both of the leading parties are actually pursuing policies, which is likely to not necessarily place any brakes on terms of the size of government spending relative to the income it gets in. And what does that mean? That means that there could be subsequent pressure in the long run-on bond deals in those regions. So again, that directly translates into an investment view. So, understanding what the dynamics are, understanding what the policy shifts could be, trying to think about the long run positioning that you take is critical to understanding the investment outlook right now.

Oscar Pulido: And it speaks to one of the themes you talked about, which is the world economy has a lot of different scenarios and. And pathways that it could take. and some of that is just due to elections and the potential policy changes that come as a result of that. Vivek, when you're an investor and you're hearing about these three themes, what should they be thinking about? what is that message to investors who now want to think about what to do in their portfolios?

Vivek Paul: I, think the really crucial one is there is a lot of potential outcomes out there. there, there is uncertainty. But this is an exciting time to be investing because leaning into risk mean there are potentially huge opportunities that we can capture. Maybe we need to do things in a little bit of a different way. Maybe we need to be a bit more dynamic. Maybe we need to think about building blocks that aren't the ones that we used in the past, but this is an exciting time. This is a time to lean into risk. This is a time when the real economy is being transformed. and I think it's exciting. it's not easy, but it's exciting.

Oscar Pulido: Well, Vivek, I know you've been busy, working with your colleagues on developing the midyear outlook and now getting the message out. So I hope you find some time to relax this summer and see how the outlook plays out. And I'm sure we'll have you back to talk about the end of 2024 and then looking ahead to 2025. But as always, thank you for joining us on The Bid.

Vivek Paul: Thanks, Oscar. Thanks for having me.

Thanks for listening to this episode of The Bid. Next week I'll be speaking with author Darius Foroux about the stoic principles of investing as we consider how investors can get ahold of their emotions to build more wealth and become better at investing. Subscribe to The Bid and don't miss the episode.

<<SPOKEN DISCLOSURES>>

This content is for informational purposes only and is not an offer or a solicitation. Reliance upon information in this material is at the sole discretion of the listener.

For full disclosures go to Blackrock.com/corporate/compliance/bid-disclosures

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