Spotting Trends: Sectors to Consider in a Changed World
• The COVID-19 pandemic has created a new trend line for our society, creating opportunities as behaviors change
• Long-term opportunities in software and clean energy exist, as well as near-term prospects for homebuilders as the economy aims to recover.
Apart from the human tragedy of COVID-19, the pandemic has created a new trend line for our society by disrupting every aspect of our daily routines, from how we make purchases and consume energy to how we stay connected. Some of these trends were in place before the pandemic. But now, they are likely to be amplified as we transition to a new world order.
Identifying true opportunities during a tectonic shift of this magnitude requires using specialized, industry-specific knowledge to capitalize on an evolving market regime.
We see three potential opportunities where we believe investors may benefit from targeted sector-based strategies – both for right now as the economy starts to recover and as the post-pandemic world continues to evolve and impact future generations.
Software: Solutions to support a new way of life
Remote access, cloud storage, and internet-based solutions were strong secular trends before COVID-19. Today’s more digitally-connected world will require more software to function. And as we said in our mid-year outlook , we see software as the backbone of our new society. As a result, software and service firms may benefit from this seismic shift in corporate and consumer behavior across a variety of dimensions: video conferencing, e-learning, telehealth, project and document management, closed system social communication tools, cloud technologies, digital payments, and cyber security.
This generation-defining shift is one reason why earnings growth for software firms are expected to grow at 16% per annum over the next three to five years – compared to 10% for the broader market – and not see double-digit declines throughout the rest of 2020 and into 2021. In fact, as shown below, while the S&P 500 is projected to have negative sales growth over the remaining three quarters of this year, software and services firms are projected to continue to grow their top line each quarter. Valuations are a bit above their long-term average for the industry1, but with a lack of growth in our current environment the premium for a growth industry with the potential to reshape society is warranted.
To position portfolios for a more digitally connected but physically separated world, consider an allocation to software and software service firms with the SPDR S&P Software & Services ETF (XSW).
Clean Energy: Powering a rebuild
The production of solar and wind energy was estimated to grow at significant pace this year,2 but as economies reopen, a spike in industrial activity and energy demand will likely accelerate the trend of seeking cheaper and more renewable sources of energy. In fact, as of June, the US is on track to produce more electricity this year from renewable power than from coal for the first time on record.3
If the past is any guide, the potential for future global fiscal stimulus with specific carveouts for green energy may further support the conversion to more renewable forms of energy consumption. After the 2008 financial crisis, South Korea put almost 80% of its stimulus spending toward climate-friendly policies and the International Monetary Fund dubbed the country’s recovery one of the swiftest and most successful in the world.4 Today, nations have already directed $40 billion to support green initiatives.5 With early polls indicating a change in leadership in the US6, greener forms of power generation may also be pushed to the forefront of any US legislative agenda – providing the economic growth that could spur new employment opportunities as the nation seeks to rebuild. Private funding has also accelerated during the pandemic; Amazon has committed $2 billion for a new Climate Pledge Fund and reported it is on track to source 100% renewable power by 2025.7
As the world turns to cleaner sources of energy, there may be no turning back. As shown below, as the great transition to greener forms of energy supply has occurred, firms focused on more sustainable forms of power generation have outperformed the broader market year-to-date (+10%), since the markets bottom on March 23rd (+14%), and over the past year (+26%) Plus, they have outperformed traditional energy firms by even much wider margins.
Source: Bloomberg Finance L.P. as of 06/22/2020. Past performance is not a guarantee of future results. Index returns do not include fees and assume the reinvestment of dividends.
To position portfolios for the great transition to greener energy sources, consider an allocation to firms focused on innovating and driving the adoption of sustainable renewables with the SPDR S&P Kensho Clean Power ETF (CNRG).
Homebuilders: Ready to build to meet demand
As many states continue to ease their COVID-19 safety restrictions, both previously-and newly-interested homebuyers have emerged in droves, sending mortgage applications to their highest level in 11 years8. And while concerns for the greater economy ebb and flow, consumer sentiment has begun to rebound – rising 10% at the end of June off the March lows. Additionally, near-zero rates for the foreseeable future and an increase in the savings rate9 – which skyrocketed to 33%, up from 12.7% the previous month due to untouched stimulus checks and decreased recreational spending10 – are likely to make refinancing, purchasing, building, and remodeling homes more attractive as the economy begins to recover.
The congruent rise in mortgage applications may show that many are reconsidering their housing options after spending months indoors under stay-at-home orders. Notably, the sea change in corporate culture, where employees may no longer need to work in a physical office, also could be driving new interest in home buying outside of urban areas. As shown below, the rise in mortgage applications has coincided with a rise new home sales. And we already have seen starter home activity (homes under $200,000), increase back to 2018 levels.11
Source: Bloomberg Finance L.P. as of 06/22/2020. Past performance is not a guarantee of future results.
Of course, an increased housing demand brings the need to furnish or remodel. Therefore, investors also should consider consumer-related businesses involved in home improvement, as the deployment of the elevated savings in consumer pockets on home goods may get discretional spending back to normal levels.
To position portfolios for a housing market that may be at the forefront of a COVID-19 recovery, consider a diversified exposure to firms engaged in building new homes, providing construction materials, as well as those involved in home improvement and furnishing/appliance retail business lines with the SPDR S&P Homebuilders ETF (XHB).
To learn more about emerging sector investing opportunities, visit our dedicated sectors webpage.