An important lesson we have learned about periods of crisis is that they often create powerful catalysts for change. Crisis breaks down barriers and accelerates the rapid adoption of efficiency. “Necessity is the mother of invention,” and in times of crisis, the adoption of smart technologies and the value of innovation are pulled forward. An early 20th century Bell Telephone advert is reported to have read “people who are quarantined are not isolated if they have Bell Telephone.”
This crisis is no different. There is a powerful acceleration of adoption because of the radical and abrupt changes that physical distancing is bringing to our lives. Communication, entertainment, commerce, healthcare and education have suddenly switched to becoming remote and digital with an order of magnitude we could never have imagined in the short-term. Digital is no longer supplemental – it is primary. Barriers to adoption have crumbled through that necessity, and lasting behavioural and attitude changes should be expected, including society’s stance on the internet, which has softened during the crisis.
This creates an environment ripe for extreme outcomes. Human beings are comfortable with averages, but extreme outcomes are all around us and often describe the history of significant alpha from an equity‑investing perspective. Extreme outcomes are heavily tied to network effects, where adoption takes on a snowball effect (a global one in this era), and that may lead to natural monopoly characteristics, including scale benefits to profitability and high barriers to entry.
One of the challenges of investing today is that a handful of companies with natural monopoly characteristics represent a huge percentage of global market cap. Identifying these stocks and sticking with them have been crucial to performance. We believe this crisis will likely compound the advantage of some of these companies and catalyse new winners.
There are many opportunities to capture the acceleration of extreme outcomes in the market today. The virus and its burden on society are forcing change. E‑commerce is an obvious beneficiary. The dominant players in the West are scaling up to meet accelerating demand, while in Latin America and Asia, multi‑format players are also seeing accelerating growth as a result of today’s challenging environment.
Second‑order beneficiaries include the select software and payment/commerce platforms that are supporting transformation, such as video streaming services – first dates, birthday drinks, and love lost over video chat. Enough said.
Enterprise systems are accelerating their shift to the cloud as work from home moves beyond the temporary. Many aspects of remote communication are turning out to be more powerful and efficient than in person. One simple example that stands out is the acceptance of digital signatures. The healthcare industry and regulators all but refused to accept digital signatures before the virus, but that is changing rapidly.
The hardware and semiconductor infrastructure to support this shift is being challenged. It must be faster, more scalable and cheaper. We believe only a handful of critical companies will be able to deliver the innovation necessary to enable this. This should create a powerful “right side of change” benefit for these select companies.
The virus itself is challenging the paradigm around healthcare. The urgency of testing and the development of a vaccine are accelerating the move to mass-scale diagnostics to test for the virus and its antibodies. Vaccine investment is creating demand for single‑use bioprocess solutions. We think that changes in healthcare investment as a result of the coronavirus are likely to be long-lasting.
We respect today’s extended valuation spread between growth/momentum and value. Caution on this dimension is warranted in the short-term and we are working hard to manage rotation risks. However, we also believe in the power of change, driven by periods of crisis. New behaviours and models that seem strange today will soon be the norm. As growth investors we need to be vigilant about extreme conditions, but always seek to put our clients on the right side of change.
Crisis often accelerates change. This time is no different.
David Eiswert, global focused growth equity strategy portfolio manager, T. Rowe Price
