2021 Midyear Market Outlook

Target Transformative Innovation

The long-term effects on our society from the COVID-19 pandemic remain unclear. Yet, the reopening of our global economy will highlight how the pandemic has changed technological use cases as well as corporate behavior, personal consumption, and the impact of government programs.

Fueled by innovation that has not been confined to a specific sector (i.e., Information Technology), style (i.e., growth), market cap (i.e., FAANG stocks), or listing exchange (i.e., NASDAQ), these unprecedented changes may create long-term growth opportunities — particularly as they become more engrained in our day-to-day lives.

In this era of transformation, targeting all the innovations disrupting our society, a catalyst fueling this transformation, as well as the specific cutting-edge industries that are receiving funding, may help you be on the right side of change.

Innovation Across Industries

Importantly, the increases in hyper-connectivity, artificial intelligence (AI), exponential processing, and robotics and automation during the pandemic reach beyond the typical use cases from the Information Technology sector. For instance, IBM saw a surge in the second quarter of 2020 for its AI-driven Watson Assistant, a platform for deploying chatbots and other customer services from a variety of providers across different industries. And American Eagle Outfitters deployed robots to help sort clothes in its warehouses to meet a surge of online orders.

In fact, 67% of firms have already accelerated investments in automation and AI.1 And 85% of companies have accelerated the digitization of employee interaction and collaboration, as shown below.2 The use of e-commerce apps, intelligent productivity functions, and robotics have brought customer channel and supply chains into the digital realm as well.

Executive Responses to How the COVID-19 Outbreak Has Changed Adoption

Artificial Intelligence’s Impact on the Workforce and Economy

In a more digitally connected world, jobs will be lost to automation, but they will also be created to meet the demands for data analysis, quality checks, and program management.

Based on these potential trends, it is estimated that globally 25% more workers than previously forecasted will need to switch occupations by 2030.3 This shift is expected to impact 105 million jobs, versus 79 million in the pre-COVID-19 scenario analysis, according to McKinsey’s “Future of Work After COVID-19” study. In the US alone, this equates to an additional 4.7 million jobs that may be affected as a result of the acceleration of technological innovations and behavioral changes.4 Overall, 30% of the world’s jobs today are at risk of being supplanted by automation by the mid-2030s,5 underscoring opportunities for firms harnessing the productive efficiencies of new technologies.

Automation is not the only change to workflows and processes. Nearly 30% of work in the US is now estimated to be performed remotely, increasing the demand for connectivity, productivity, and security software platforms to facilitate these functions.6 Company statements support this trend. Based on transcripts of company filings and analyst meetings compiled by Barclays, terms related to the theme of “Next-Generation Workforce” rose by 4,857% in 2020, increasing from 44 firms in 2019 to 2,181 by the end of 2020.7

A McKinsey report also found that at least 50% of companies already have adopted AI in at least one business function today, and this figure is expected to increase as firms seek to optimize business processes and decision making.8 Given the significant adoption of AI, PriceWaterhouseCoopers (PwC) estimates it could increase global GDP by $15 trillion by 2030.9

However, it’s not just AI that may provide economic benefits. According to another McKinsey study, biological innovations also could have a direct $2 to $4 trillion economic impact per year by 2035. More than half of which is expected to come from industries outside of traditional health care that are likely to benefit from scientific breakthroughs.10 Gene therapy for diseases, hybrid systems that connect nervous systems to living organisms (i.e., robotic arms), and synthetic biology aimed at creating more sustainable biosystems are all examples of these type of innovations that could improve our health, safety, and longevity.

The potential for novel treatments also supports why biotech product sales are projected to grow at a compound annual growth rate of 10% through 2026, as opposed to 6% for conventional treatments.11 As a result, biotech products will likely represent more than half of the top 100 products sold by then.12 Not surprisingly, in the same transcript analysis as mentioned earlier, terms related to “Modern Vaccines” increased by 1,271% over their prior five-year average rate.13

Changes in Consumer Behavior

Consumer behavior has drastically changed during the pandemic as well. Most significantly, e-commerce has grown three times faster than it had before the pandemic14 and nearly 60% of consumers now use two or more digital payment methods (up from 25% in 2019).15 In fact, according to a report from Square, the share of cashless businesses nearly doubled around the world. In the US, that share increased to 15% from 8%.16 Prospects for mobile point-of-sale payments remain bright, considering that global mobile payment transaction total values are expected to increase to $4.6 trillion by 2024 — a 31% compound annual growth rate from today.17

Connected consumer discretionary items are also becoming more commonplace. According to Global Market Insights, the virtual fitness market is set to exceed $30 billion by 2026,18 with on-demand virtual fitness streaming expected to grow around 28% per year over the next five years. Additionally, there has been an increase in the use of online platforms for other consumer-based services. According to a McKinsey Consumer Pulse survey, three quarters of people using digital channels for the first time during the pandemic say they will continue using them when things return to “normal.”19 Statement-based analysis reflects this trend as well, with comments related to “Telehealth” increasing by 311% from 2019 to 2020 based on earnings transcript analysis performed by Barclays.20

Software as a Catalyst to Innovation

Hyper-connectivity is creating change and long-term growth opportunities, considering that the number of in-home connected devices is expected to increase from 10 to 20 by 2025.21 Overall, the number of connected devices in use is expected to grow to over 31 billion by 2025, up from 10 billion at the start of 2020. That’s a 21% compound annual growth rate.22 The innovations here could range from supply chain management, to logistics and fulfillment centers, last mile delivery, and the use of drones. Overall, the Internet of Things (IoT) market is expected to grow to $1.5 trillion in value by 2027, a 24.9% growth rate.23

Given that software technology will be instrumental in facilitating many of the innovations discussed, it is not a surprise to see that spending on enterprise software and information technology (IT) services has some of the highest expected growth rates.

Enterprise software has the highest rate in 2021 and 2022, and alongside IT Services, both are outpacing the broader IT industry in 2022, as shown below. Additionally, IDC estimates that over the next five years, all growth in traditional tech spending will be driven by just four platforms — cloud, mobile, social, and big data/analytics — as the digital transformation accelerates.24 Meanwhile, next-gen security platforms related to new technologies (AI, IoT, blockchain) are also likely to continue to drive growth.

Worldwide Information Technology Spending Forecast

Overall, software firms are uniquely positioned to benefit from changes in corporate and consumer behavior. To a degree, this aligns with past expansions. In prior expansionary periods coming out of a recovery, technology firms have, on average, had above market performance — stemming from tailwinds from an increase in capital expenditures as overall corporate profits in the economy expand.25 In this expansion, we’d expect those capital expenditure dollars to be spent on upgrading software services and right-sizing company platforms to adhere to this new transformative era.

Regulation and Government Spending Accelerate Disruptive Innovation

With the 2021 Report Card for America’s Infrastructure finding that 11 of the 17 categories, such as transit, wastewater, roads, and aviation, are below standard and have a strong risk of failure,26 infrastructure represents one area that could be targeted by policies. Per the report card, the total investment gap of US infrastructure has gone up to $2.6 trillion over 10 years.27 It is likely that old, aging infrastructure will be replaced with more sustainable and connected technologies.

We have already witnessed greater use of smart technology to solve infrastructure problems. For example, in the Chinese city of Hangzhou, an AI-based smart “City Brain” has helped reduce traffic jams by 15%.28 And Amsterdam has been experimenting with offering home energy storage units and solar panels to households that are connected to the city's smart grid.29 Europe is on the leading edge of this global trend, with the EU encouraging members to develop smart cities and the European Commission providing financial support.30

While the US has lagged, the potential for significant progress remains with the proposed American Jobs Plan that earmarks funding for modernizing transportation systems, building infrastructure for electric vehicles, and improving drinking water systems.

The $2.2 trillion plan supports:31

  • Transportation infrastructure: $621 billion
  • Research and development investments: $180 billion
  • Drinking water infrastructure: $111 billion
  • Digital infrastructure in high-speed broadband: $100 billion
  • Electric-grid and clean energy: $100 billion
  • Clean energy manufacturing: $46 billion

This planned spending could amplify the existing trend of smart cities. In fact, PwC expects a steady increase of smart city development around the world over the next few years — with the total value of the global smart city market projected to exceed $2.5 trillion by 2025.32

Implementation Ideas

Idiosyncratic or firm-specific risk can be elevated when targeting the innovators transforming society. As a result, a diversified non-market-cap-weighted approach, without taking on significant single-stock risk, may be appropriate to pursue these growth opportunities.

To target broad-based innovation transforming our society, consider:

To focus on a primary catalyst fueling innovation, consider:

To position for infrastructure innovation, consider: