Olga Bitel
William Blair Global Strategist

Simon Fennel
William Blair Portfolio Manager

Our 2024 Global Outlook

December 21, 2023 | 52:43

Will 2024 be the first year of “normal” economic expansion post-COVID? In this episode of The Active Share, Hugo sits down with William Blair’s Olga Bitel, partner, global strategist, and Simon Fennell, partner, portfolio manager, for a wide-ranging conversation on the outlook for 2024. Together, they touch on key topics like inflation and interest rates, Japan’s investment story, the impact of generative artificial intelligence (AI) and glucagon-like peptide-1 (GLP-1) medications, and what new growth opportunities could be on the horizon.

Meet Our Moderator

Hugo Scott-Gall, Partner

00:36 Host Hugo Scott-Gall introduces today’s guests, Olga Bitel and Simon Fennell.
01:10 What will happen with inflation in 2024?
12:13 Simon’s observations on the changing market in Japan.
20:52 The low levels of economic growth in China.
28:30 The role of generative AI in the productivity revolution.
33:08 Discussing scarcity to abundance.
37:24 Olga and Simon highlight 2024’s changes and constants.
42:45 How company strategy is changing.
46:35 Olga explains how GDP and interest rates are changing.
Hugo Scott-Gall: Welcome to The Active Share podcast that explores less obvious investing insights in a world that’s always changing. I’m your host, Hugo Scott-Gall. Today, I am delighted to have with me Simon Fennell and Olga Bitel. They’re going to talk about our outlook for 2024-macro-thematic to what’s on CEOs’ minds. Olga is our economist and strategist. She’s been with William Blair for a long time, lucky us. And Simon is a portfolio manager on a number of different portfolios. Again, he has been at William Blair for over a decade.

So, Olga and Simon, both welcome back to the show.

Simon Fennell: Thank you very much.

Olga Bitel: Thank you, Hugo. Delighted to join you guys.

Hugo Scott-Gall: Yes. Well, unlike Simon, you weren’t asking to come on, so that’s duly noted. Let’s kick off, Olga, with you, which is if 2023 was all about when is inflation going to stop falling, as it increased at a slower rate, what’s 2024 going to be about when it comes to inflation?

Olga Bitel: 2024 is shaping up to be a really interesting and exciting year as usual. It’s also shaping up to be a very ordinary expansion-like year. What I mean by that is that 2024 may well prove to be the very first truly post-COVID year, in which we are sitting comfortably in an expansion with all of that entails. Expansion is all about broad growth, so think about circa two percent in the U.S., a bit less in Europe, and who knows what we’re going to get in Japan. Hopefully, a significant acceleration, which I’m sure Simon will be delighted to discuss from a corporate perspective a bit later on.

So, all in all, this is shaping up to be quite a good year. Inflation is increasingly in the rearview mirror. I would have argued that it was probably in the rearview mirror already in the second half of 2023. We are decelerating with each monthly print. And pretty soon, if not already, we are going to be starting the debate on whether monetary policy settings are too tight for the level of inflation that we currently are enjoying.

Hugo Scott-Gall: That’s a good and positive but may be slightly provocative statement. So, if I could be devil’s advocate, why are you so sure that inflation is in the rearview mirror and done? Is that because of the nature of the inflation, the characteristics of it? Or is that because as you think about some of the, I guess, arguments for higher for longer inflation revolve around certainly around the fact, demographics, you have an aging population, and baby boomers retiring, shrinking the workforce.

You have artificial scarcity introduced by deglobalization or increased geopolitical tensions that mean that supply chains are no longer fully optimized. There are those who argue that maybe we’re a brief respite but inflation will come roaring back. Why are they wrong?

Olga Bitel: Let’s put together a couple of terms. When we’re looking forward it’s really difficult to say with any kind of certainty, right, what’s right, and what’s wrong. But the latest bought of inflation that we all experienced post-COVID was most likely of the supply side variety, meaning that the supply side could not adjust rapidly enough to the massive shocks that permeated it in the aftermath of what was a very abrupt medically driven closure of large swathes of the economies. And not just in the U.S. and Europe, but globally.

So, that led to massive distortions in the supply chains of all kinds of goods and increasingly services, and that’s what led to the bouts of inflation that we’ve experienced. Just to put a finer point on it, in the U.S., you saw that most pervasively in housing. In Europe, which imports a lot of its energy, you saw that in the energy prices. And then over to Asia, specifically in Japan, you saw that most vehemently in the food prices, which of course Japan imports a lot of its food input.

And so, it’s very much a supply-related story all over the world, and so as supply shocks tend to go away over time, suppliers adjust, companies adjust, demand adjusts. That kind of bought of inflation is unlikely to persist. So, when we look forward, all of the structural changes and challenges that you highlighted, Hugo, are still here, but they’ve been with us for quite a long time. In the case of Japan for several decades, in the case of the U.S. more recently, for about a decade.

And they certainly can depress or express inflation in different ways, most certainly in relative prices if not the absolute price level changes across the board. It’s quite difficult to argue that demographics alone is going to result in higher inflation moving forward. Having said that, when we look out this decade, with stronger growth, even marginally stronger growth, you would see slightly stronger inflation than what we saw in the last decade. It’s just the argument here is that the last decade was unusually depressed, both in terms of growth and inflation.

And so, on a go-forward basis, if I were to tell you that developed markets are going to grow by two plus percent on a sustainable basis, with inflation of about two and a half or so percent on a sustainable basis, that would be a really welcome outcome, and nobody I think would suggest that is an increased bout of inflation. But in fact, that between meaningfully higher than what we experienced in the decade after the Global Financial Crisis. I think that’s the outlook for now.

Hugo Scott-Gall: So, benign inflation should, in theory, allow interest rates to come down. If they don’t come down you have high real interest rates, which if they’re too high can be highly restrictive, and cramping, and suffocating for the economy. So, if the Fed acts in the right way, or if the Fed sees inflation is no longer a problem, enables it to cut rates, then that would be supportive of your argument of an economic expansion.

Just talk a little bit about the risks of what if the Fed is too slow. That can lead to a recession because of the effect of high real interest rates. Can you talk a little bit about that? Then after that, I want to talk a bit about fiscal situation and debt issuance and levels of debt, and whether that feeds into a higher cost of debt.

Olga Bitel: So, let’s tackle real rates. So, of course, when the Fed and other central banks, notably the ECB, the Bank of England, the Bank of Japan, and others set monetary policy, what they’re really aiming for are real rates, which is nominal rates minus the rate of inflation. So, when all else is equal, when your rate of inflation decelerates or comes down, your de facto real rate, which we don’t observe but we impute from unchanged monetary policy setting, becomes higher.

And we’re observing that in the U.S. in real time. There are different ways to proxy real rates. Of course, you can take the 10-year yield. You can take the Fed funds rate and subtract the current rates of inflation, and all of these are pointing to structurally higher real rates today than we’ve enjoyed in the past. So much so that the U.S. real rates are kind of breaching or about to breach the two percent threshold. And two percent real rate is quite a challenging place for a mature economy at the frontier of technological progress to be at.

So, the consensus among economists, I believe, is around one to one and a half percent real rate. That’s probably what the Fed and other central banks will aim toward. As inflation continues to decelerate, if we don’t see a change in the monetary policy stance, that effectively means that the Fed is raising real rates. And so, the challenge for monetary policy next year is to be proactive and not wait for the last, or last month’s CPI print to be sufficiently low, but to move well in advance of that to begin to signal to the market the rates need to come down.

Not so that the Fed can be more accommodative, but so the Fed can maintain its neutral policy setting. This is all about maintaining the current restrictive or moderately restrictive monetary policy, not tightening further. And if inflation is coming down and the Fed is not moving that de facto means that the Fed is tightening.

Hugo Scott-Gall: So, what about the second part of my question that I almost asked, that size of debt issuance, size of deficits, may well mean there’s a buyer’s strike in the bond markets, and that pushes up the risk premium on debt. So, you might have falling inflation, but actually, what you’re able to raise is the government might be restricted by reluctant bond buyers who are getting concerned over the creditworthiness to just the size of debt relative to nominal GDP. Because that was a prevalent argument, certainly in Q3 of this year, where you saw the U.S. 10-year go up above five percent.

In your view is that more fitting a narrative of the price action, or is that something that concerns you in the medium term?

Olga Bitel: I think what’s missing in what you’ve outlined, and it was certainly missing in the discourse around the Q3 blowout in interest rates, as you rightly pointed out, was in one word, growth. To elaborate on that further, economic growth in the third quarter in the U.S., you know, when annualized, clocked in at a five percent rate. The U.S. is obviously not a five percent grower on a consistent basis. But if it were to grow that fast, interest rates would have to be quite a bit stronger than they are today.

That’s really what, in hindsight, was behind what we saw in September of this year vis-à-vis the 10-year and really all up and down the curve. And the same argument broadly applies to the question at hand. Specifically, yes the U.S. fiscal deficits are very large. They’re historically extremely large, especially given where we are in economic growth. But they’re not driven by excessive spending. Given the IRA and the CHIPS Act, and the IRA, for those on the call, we’re referring here not to anything sinister, but to the Inflation Reduction Act that was passed several years ago.

These are attempts to jumpstart the U.S. industrial policy, which, of course, has been and continues to be alive and well, and to enable companies, incentivize companies, via tax cuts and other incentives, to further their investments in greenfield technology, in greening their operations, in putting out more semiconductors in the U.S., in lessening their dependence on Chinese supply chains, etc. And so, a lot of that is in the form of lower taxes. That fiscal deficit is all about lower tax intake, specifically from the corporate side rather than excessive or profligate spending on the part of the government.

The idea here is that this is about CapEx, not OpEx, so government spending is about OpEx, and presumably tax credits of the sort that I just outlined are about CapEx, such that we should expect to see stronger GDP growth in the coming years. So, this is an investment, not an operational leverage. And so, the results of this deficit, if you will, should be quite a bit different in terms of future GDP and future GDP growth, I would argue, at this point.

Hugo Scott-Gall: So, you are quite constructed, optimistic next year is a much more normal year. All these COVID distortions and there’s fiscal and monetary response to COVID, have worked their way through. We’ve got benign, becalmed inflation. We’ve got falling interest rates, and we’re in expansion. We’ve got economic growth. So, that’s all pretty good. That’s almost the dream ticket in some ways for risk assets.

But of course, one thing you touched on there, there is a question of where is growth. It’s very important, and growth doesn’t stay in the same place. It moves around, whether that is by country, whether that is by industry, whether that is by thematic. I want to bring you in, Simon, to talk about this question of where is growth. You’ve just come back from a trip with Olga, I might add, to Japan. That is a land of rising opportunity potentially, and this may well see relatively faster, more attractive growth, certainly versus its own issue, but also versus its developed market peer group. What can you tell us about your trip to Japan?

Simon Fennell: Well, the first thing really is the historical context. Japan is coming out of 30 years or so of deflation, and that’s turned around. And that change, that shift, has been very important in a number of different areas. I think the first is in investor psychology, that there actually is potential for something different in Japan. Now, that’s been a refrain that’s not been rewarded over years, over the last 30 years, frankly.

But actually, the thought that there is a difference this time is important. What’s the growth that we’re potentially talking about? Well, one of the interesting things around the inflation side are the expectations of inflation and how they’re moving through the economy. I think we point clearly to wage inflation and wage expectations, that the changes that would come through we saw just below 3.6% in the spring of this year, with the possibility of a similar or higher number going into next year, 2024, which, again, starts to change the dynamic, I think, in terms of expectations, both at a consumer level, corporate level, and I think at the investor level.

That’s part of the reason around the good performance in Japanese stocks this year, but I think it’s broader. I think what we saw when we were in Japan was a consistent effort across quite a broad consensus that there was possibility for change. This move from deflation to some inflation is matched by a resolve in quite a different area or a different group of participants. The first being the stock exchange itself announced earlier this year, at the beginning of this year, changes to potentially listing on the exchange if you’re to be trading below book value.

The possibility that you will be delisted from the Tokyo Stock Exchange has changed the approach at the corporate management level, and we’re beginning to see some of the areas of change structurally in Japan that have been really absolutely unchanged for 30 years or so, and the structural industrial elements that you see in Japan that we haven’t really questioned for a while, things like cross shareholdings, are beginning to be unwound. Very high levels of cash on balance sheets, very low net gearing. I think around the two percent mark in aggregate, with nearly half the companies on the exchange in a cash-positive positioning.

This of course in stark contrast to the U.S., but changes here are occurring. And very interestingly they’re almost occurring on a daily basis. We’re seeing unwindings of cross shareholdings, admittedly small, but across the likes of Toyota unwinding some of its cross shareholdings. You’re seeing the potential for corporate M&A in places like, well, the drug stocks to begin with, where international private equity groups are being linked with potential takeovers. And this is producing something of a virtuous circle.

Now, it doesn’t matter if the companies themselves aren’t doing better, but actually, there’s some change in pricing amongst goods on a broad corporate basis, not just on the consumer side but beyond. That’s actually driving some earnings growth as well. So, it’s quite a constructive picture. It’s slightly different to the Abenomics, three arrows of 10 years ago or so because I think there’s a bit more of a timetable to it because it’s being pushed so specifically by the exchange.

And as that occurs, people are beginning to question some of those almost unwritten rules about Japanese business, particularly amongst the competition and competitive elements. There are 10 major car companies in Japan. Well, that’s in stark contrast to the European and the U.S. I think there are 11 printer companies in Japan. Just the lack of M&A has been very significant. If Japan is to get these returns up, it will mean a different structural landscape to a lot of their industrial powerhouses. And I think that would be very positive if that was the case.

Hugo Scott-Gall: So Olga, is Japan a credible piece of contrary evidence to the idea that if you’re heavily indebted, you’ve got a shrinking population, you’ve got an aging population, that growth isn’t possible?

Olga Bitel: No. I think what Simon is arguing, and I back him up fully and willingly on this, is that it will prove to be just the opposite. Although a lot is said about demographics and the importance of demographics in GDP growth, what really drives GDP growth in Japan and the U.S., and everywhere else for that matter, is productivity gains. So, when you look at the fastest growers in the world, and of course that would be China over the last three, four decades, and other places all around the world, whether growth is anemic or stellar, you see that in both cases it’s about productivity growth and demographics in the broadest sense is a small contributor or detractor in some cases, of that overall growth.

And so, when we’re looking at productivity growth and gains, there is no better place to start looking, is by appreciating what a change when you’re going from a low but persistent deflation to low but persistent inflation can mean. GDP at the end of the day is nothing more than the sum of wages and corporate earnings.

When you’ve got volume minus pricing, and wages have to be stagnant to accommodate that constraint, and you’re now moving to something like volumes plus pricing, where nominal variables are now starting to grow, and hopefully, that growth will be sustained, that’s a totally different dynamic and it alchemizes a lot of the changes that we are talking about here. And to help those changes, Simon just touched on the corporate restructuring side. The government is helping in terms of driving liquidity into the Japanese markets by reforming the NISA accounts.

So, these are retail accounts for households. They’re tax-exempt. They’ve been around for several years, since 2014, I believe. And from January of 2024, they are completely restructured such that anybody and everybody is encouraged to put their money, which is estimated over half of the savings in Japan is held in cash still. Again, a function of persistent deflation, back to work, back to growth, back to profitable returns. And so, that’s not a trivial change that we’re seeing there from all facets of the Japanese society, be it the stock exchange, be it the corporates themselves, the household sector, and of course the government.

Hugo Scott-Gall: So, Japan is an incredible place for accelerating growth. Let’s talk a little bit about China, which you would maybe argue is where growth used to be, but is China running out of growth? I’ll direct that first to you, Olga, and then to you, Si, just to discuss bottom-up patterns of growth we see and indeed are looking for when it comes to looking at individual companies. But Olga, do you push back against the assertion that China is heading towards being either low growth or even ex-growth?

Olga Bitel: So, economic growth in China this year has certainly been very challenged, indeed more challenged than we and many others have expected. They did away rather abruptly with their COVID restriction-related policies at the beginning of the year. And the expectations were high that growth was going to accelerate from there onwards, and in fact, the opposite occurred after Q1 of better performance and better economic growth. Growth really petered out, such that I would argue that at this point, it is probably at unacceptably low levels.

Unacceptably for the domestic constituents, and of course unacceptably low for the Chinese government. So, what they do from here on bears watching, but I do think it’s probably premature for us to write China off in terms of its growth, both aspirations and its ability to deliver on those aspirations. Under the hood and under the surface, you would be remiss if you thought about missing China’s growth, and you looked at their auto exports in the last several years. Specifically, while we’ve all been lamenting the lack of China’s growth, the exports in the car-making arena rose ninefold in just three years.

So, that’s right, that’s a ninefold increase in just three years. That is pretty astronomical by any measure. And a large chunk of that, more than half actually, is electric vehicles, EVs. And by all standards, and by all discourse, the models that the Chinese automakers are now putting out are some of the best in the world, so much so that the European Union is now genuinely worried about a bilateral trade deficit for the first time between the EU and China. That is not something that has been on a geopolitical menu probably ever.

So, another area where China is probably very keen to close its technological gap is, obviously, in the semiconductor space. Anything that has to do with the next leg of technological progress, be it in AI, be it in quantum computing, be it in next-generation chips and material sciences, etc., increasingly also in healthcare is probably too early for us to write off China’s continued efforts to improve and grow. How, and whether, and when that manifests itself in better consumption remains to be seen. I continue to be of the view that consumption growth in China will remain relatively depressed for several reasons.

And of course, that has to do with the aftermath of COVID. So, the Chinese households were not supported during COVID to anywhere near the same extent as we were in the West. So, there were no large handouts. There were no handouts of any sort. So, most households are nursing significant losses of wealth over the past several years, and it takes a while to rebuild those household balance sheets. But if corporates are pushing the technology frontier, if the opportunity exists to continue doing what they’ve been doing and arguably do it better, I think there will still be profitable growth to come from China.

Now, whether we as investors are able to exploit that growth is a different question, but I think to write off China’s technological prowess and economic growth is probably premature.

Simon Fennell: This was one of the big disappointments of the year. We’ve known of course for a while the nature of Chinese growth has not been domestic consumption. And we thought that actually, that could change, especially as you mentioned that abrupt turnaround in terms of the COVID restrictions coming off earlier this year. Every country saw some element of revenge spending or a COVID bump, whether it was on consumer products or on consumer services, travel is obviously a key area of that, but we’ve seen it almost everywhere else, but we did not see it in China.

Actually, the nature of the spending pattern at the household level seemed to change to the downside again, where there was almost further pulling in of horns, and it really was a very weak picture. Now, it’s not necessarily weak for everyone or every class of consumption, but in the round, it was clearly weak, and we’ve got further issues of course on the property side as well. So, that nature of household wealth and wealth creation went in reverse from a Chinese perspective.

We are seeing almost on a daily basis discussions now about initiatives from Chinese leadership in order to boost confidence or to rebuild an element of consumption patterns. But actually, we haven’t really seen it yet. And again, from the world GDP perspective, in previous dips it’s been Chinese leadership from a growth perspective that’s been very positive. We don’t necessarily have it now. Arguably, we might not necessarily need it to the same extent that we had before. We’ve got different places with growth. We’ve already mentioned Japan.

But I do think that when we look back on this year that element of Chinese consumption and Chinese growth overall will be the clearest point of disappointment.

Hugo Scott-Gall: One of the big thematics that has been a big driver of investor performance this year has been generative AI. When you think about that, that must have a role to play in a country like China. Is that something that perhaps could surprise to the upside in terms of productivity it enables in companies and their ability to hang onto those gains? Is that something that is relevant to most countries in the world, but particularly so a big country like China? Is there room, do you think, for upside surprise as AI diffuses through China’s economy slightly?

Simon Fennell: I think it can be. Whether it’s the 2024 surprise, I’m not sure the rollout would necessarily be as quick to see a return from a productivity level. We saw some of the Indian IT services companies last week. AI was of course front and center. Their best guess for what they’ve done internally, and this is among the Indian megas, was that it’s a 20% to 30% uplift to productivity amongst their own workforce.

Well, that is a fascinating number, and again, you could imagine that rolled out more broadly would result in significant changes in productivity. And from that perspective, would be hugely positive. Whether it’s in the very short term or not, i.e. ’24, I think arguably it will be a ’25, ’6, ’7, beyond. The generative AI discussion, again, I still think that the Netscape 95 moment is applicable here. But if that’s the case, and we’re probably moving at faster time speeds than we were back 25, 30 years ago, that took a while from a Netscape perspective, to move through. And I think the same will be true here on the AI perspective.

I think that’s an encouraging number that some of the leading Indian tech companies are talking about. I just think it’s probably going to be ’25, ’6, ’7, rather than next year.

Hugo Scott-Gall: Olga, as an economist, how do you think about the current wave of AI, which is increasingly a broad and blunt term? But do you think that generative AI is going to show up in the argument, the old argument, old saying about productivity? You can see it everywhere apart from the numbers. Is this actually going to show up in the numbers? And is this something that will justify the enthusiasm from the implied growth and benefits of AI in some companies’ share prices this year? Is this one for real, or is this more hype and less actual contribution to productivity? And does it show up in corporate profits?

Does it show up in the consumer surplus? How does this really manifest in the economy? So, with your economist hat, thinking about the patterns around waves, technological surges, is this one for real, do you think?

Olga Bitel: Thank you, Hugo, for the question. So, the first point to make is they’ve all been for real. It’s just that there is a huge time lag between when we as investors get excited about new technology and when we see companies at the leading and sometimes the bleeding edge put forth this technology, and the time in which we see it in the aggregate economic statistics. So, for something to show up in the aggregate numbers, so this is with the boring economist hat, more than half the companies need to be using it. So, for productivity gains to be really visible in an aggregate economic sense, it would take a few years at least.

So, we’re in tandem with what Simon just said. We’re probably looking closer to the end of this decade before we can conclusively see this in the numbers. It will take a few more years for the economists to debate what those impacts are to finally conclude that it is indeed an AI productivity-boosting event or a series of events. We as investors are going to see the impact of AI a lot sooner.

As you already highlighted, we’re already seeing it in the companies who are building the foundations for what is likely to be the benefits of AI on a going-forward basis, whether it’s the companies that are building the foundation models, or the IT infrastructure that is required to bring this about. These are the frontrunners. They’re the ones who see earnings growth inflection first. But the proliferation of the power of AI is really just starting. Whether it’s on the productivity gains, and being able to teach everyone faster, and to close the gap between the mediocre and the better in terms of the repeatable skills.

That’s one area that everybody is excited about, and arguably we’re going to see benefits here first. But I personally am most excited about the changes that we’re likely to see in the speed and the quality of material sciences and in the speed and the quality of improvements in the healthcare space. It’s not an accident that large pharma companies are fast becoming data companies. And so, the implications of that are yet to come, and we’ll probably unveil themselves in various guises in terms of better treatments, in terms of radically new treatments, etc., over the years and decades to come.

Hugo Scott-Gall: So, therefore, one should be, you know, you painted a nice picture of next year, or of ’24, but everything you just said I think makes a lot of sense. And, therefore, we should be talking about some form of productivity revolution, some form of big productivity contribution to economic growth. And that really is different. We like to think in time periods. The rest of this decade does seem to look different from certainly the 2010s where you had the diffusion of the internet, which really perhaps at its core delivered a lot of convenience. And that really showed up more, I would argue, in the consumer surplus.

You didn’t have to wait so long for a taxi. That was great. It didn’t massively change overall the economic growth. It was nice as a consumer to know you were wasting less time. Everything you’re saying seems really structurally, really quite different, and quite profound. I assume that for that, we’re really talking about scarcity to abundance. So, if I really want another growth thematic, and I’m interested in both of your views. I’ll throw it to you first, Simon, is, again, we don’t fully yet know the impact of weight loss drugs. But we know that it is likely that obesity has many costs attached to it at a societal level, at the cost of it.

So, is this another moment of a problem, sometimes defined as scarcity moving to abundance? As in it was difficult to solve obesity, but basically now it’s maybe becoming pretty easier with all sorts of first and second-order benefits. Do you think, Simon, that this is a clear growth thematic, again, whose implications we don’t yet fully understand, but we know that it is moving towards a much, much greater benefit to society, and again, should begin to manifest in productivity?

Simon Fennell: I think that idea of scarcity to abundance is fascinating, can be applied to a lot of different areas. What’s interesting about the GLP-1s this year, I guess, in terms of investment performance, is that it’s really almost an antidote for part of that scarcity to abundance. The first part of that was that calories went from scarcity to abundant. The follow-up to that is now an approach to the abundance of calories that you’re seeing here from GLP-1s. It was Wallis Simpson who said that you can never be too rich or too thin.

And those two areas seem to be pretty interesting this year in ’23, with GLP-1s, Novo Nordisk becoming Europe’s largest market cap, beating LVMH, the previous largest cap. Why I think it’s interesting on GLP-1s, and it’s more than just a fad, is, as you say, the second and third-order effects here are fascinating. If we’ve got initially some elements of obesity that there’s significant weight loss and it’s kept off, that’s important enough. The accompanying data that we’ve seen, particularly on cardiovascular and stroke is so good as to make you think that actually, the abundance we’re talking about here is health.

There’s a healthcare element, or a wellness element that perhaps these drugs are able to provide much greater standards of living from a health perspective that health span becomes a much more important part. And again, we’ve seen, perhaps, if it’s a tertiary effect, potential GLP-1 impacts on areas around addiction in particular, and almost of the behavioral element that’s accompanying it. So, these things actually start to compound, I think, and again, we can think perhaps of first-order effects, maybe to second, but third, fourth, and fifth start to get very distant.

Again, going back to the Netscape 95 moment, you couldn’t see the mobile internet from just the start of the internet. You couldn’t see the app economy from that first moment. But actually, these things unfold quite slowly, and yet it always looks as if it was natural and inevitable afterward. We’ve been talking a lot here around mobile, the nature of the rollout, and penetration of cellular technology, starting in the ’90s.

And again, from those first McKinsey reports of how many people would need a mobile to pushing out to see whether it was actually going to be a consumer product or just a business product, and after that whether you could move to 50% penetration, and then, of course, the inevitability of mass communication and its ubiquity. I think that there are potentials around that with some of what we’ve seen from GLP-1s, from some of what we’re seeing around AI. We question it, to begin with. We wonder who would want it.

Then suddenly we find it becomes ubiquitous quite clearly, and the profile and the value that it provides is suddenly only self-evident 10 years after we’ve had it roll out. So, I think it’s exciting from that perspective. I think we have seen things in the past that look like these types of curves. But again, it is incredibly exciting to think about how they may be used in ways that we can’t actually quite imagine at the moment.

Hugo Scott-Gall: Olga what else is on your radar? What is nestling in your entrée when it comes to where do you think growth can be?

Olga Bitel: That’s always a difficult but also the most exciting question. So, some of the things that we are tracking, and it’s perpetually, and some argue perennially, has been the next big thing for the last 50 years, but it might actually be that, is nuclear fusion. If we get to the point where energy is almost free and is completely abundant, can we just think about the possibilities that that kind of world brings on? We do have reactors today that are able to sustain that nuclear reaction for an indefinite period of time. They are not yet net producers. In other words, they take in more energy than they put out.

But that is a massive change from where we were just five years ago. So, this is not a theme for 2024 by any means. But I would not at all be surprised, Hugo, if you and I and Simon are talking about this next year and in the years to come. And if and when that actually becomes — not if but when this actually becomes a reality. This too will be a game changer, and paradoxically, and perhaps somewhat counter-intuitive, AI is aiding greatly in bringing that forth.

So, while in the aggregate, going back to my boring economist hat, while nobody in the aggregate economic statistics will link this back to AI, it’s quite possible that the changes in the compute power and evolution of AI-enhanced analytics can deliver faster, better improvements in this area as well. So, stay tuned, but this is very exciting. Food and energy are the two most key inputs into producing just about anything to any sort of wealth creation whatsoever. And if we succeed in making energy almost free and completely abundant, that can change the possibilities of where we see growth and how we live as humans.

Hugo Scott-Gall: Simon, is there anything that you would throw into that mix of either emerging growth thematic, or underestimated, or underrated growth thematic, to help answer the question where growth is going to be?

Simon Fennell: Well, sometimes it’s interesting to ask that question under the guise of what’s not changing. And you often use the Bezos line that the demand for cheap products very fast is not going to change. One thing that we see not changing is that demand for compute power. The nature of the problems to be solved and the ability to solve them with extra compute power I think is actually something that is not changing at all and is going to be the same in ’23, ’4, ’5, ’33, ’4, ’5. That I think is never lost on the market when we bring compute power at scale.

Whether that’s going to be cloud, whether it’s going to be courtesy of new chip architecture, whether it’s going to be in terms of new compute architecture if it was with quantum, that demand for compute is not going to be changing. Now, what are we going to be applying that to? Well, the three of us have talked about protein folding very specifically, previously, and the nature of the speed that the compute power brings to it, and how that radically changes our approach to either the nature of drug discovery. Olga’s already talked about material science.

But really as we continue to push that out, your last podcast on the space side, I think, again, this is all predicated on the demand for and the ability to provide compute power at ever cheaper rates, faster and cheaper rates, faster and cheaper continues to be something that we’ve all benefited from a Moore’s Law perspective. Discussions on whether Moore’s law is breaking down or whether it’s ending seem to be much more on the backburner. And this demand for compute power is constant.

And again, if we’re going to be able to move that element of scarcity to abundance into an energy perspective, this is when things really do start to change. So, it’s a little bit of a different approach to your question, one you use a lot, so I thought I’d throw it back at you. But what’s not changing, I think, can be an important part of that.

And we could apply it very much to the consumer element when we think about consumer companies, again, what they have to consistently provide, better, cheaper, that is not going to go out of fashion, whether it’s from Amazon or beyond, those models that continue to work along those lines will continue and will maintain leadership around the place. So, again, it’s so exciting to think about things that are changing. It’s important for us to think about some of those constants that are around the place because I think from a portfolio perspective they’re crucial as well.

Hugo Scott-Gall: I’ll finish two more questions. The first one is going to go to you, Simon, around your sense of how company strategy is changing, how CEOs are thinking, and how that’s maybe reflective of what Olga said at the start, that ’24 may well be the first normal year in quite a few years. I can ask you that, but then I was going to ask you, Olga, just to come back to where is growth, and maybe talk a little bit about emerging markets more broadly, and specifically India, which seems to be the poster child of how the growth machine should work, and that is doing everything that an emerging EM should be doing.

So, Simon to you first, do you get a sense from many companies that we meet, that our analysts meet, that CEOs are beginning to think differently about the world, whether that is because of some of the things we’ve talked about, obviously, AI, but also geopolitically the world is a little different. China is a place that’s perhaps tougher to do business. You’ve seen foreign direct investment fall. So, maybe they think about how the world fits together a bit differently.

Maybe they’re thinking their strategy has to change or certainly embrace an AI that may well change how they do what they do, or how they understand their customers. Do you get a sense of shift in corporate thinking, strategic thinking, in a sort-of normalized, beyond COVID world?

Simon Fennell: I definitely do. I think we moved out from COVID, which was perhaps what we thought at the time to be the ultimate disruptor if markets are shut down if societies are shut down. And then we’ve moved what we thought was back into some level of normality to have a geopolitical shift which we hadn’t necessarily seen before, war in Europe. We’ve seen further elements of conflict on a global basis. Very significant broadening actually of conflict throughout the world, and that has changed, I think, the nature of our expectations potentially of growth, with the third point that AI comes firmly into the picture.

And that, I think, changes the way that CEOs are trying to allocate capital and the way that they’re thinking about growth. Some of the more traditional elements that you thought were going to be growth areas forever have shifted. And others have been opened up. So, when we think about capital allocation for the best companies, it’s such a core skill of the best managements in the world. I do think the environment is changing enough such that capital allocation skill is absolutely front and center, and the best companies are clearly aware of their cost of capital and where to allocate that capital from a returns perspective.

And I think those three elements that we’ve highlighted are really, really forcing some focus. The best ones, the best companies, the highest quality, actually are seeing all of this as an opportunity. The threats are clearly there as well, and again, I think we see that the stakes arguably perhaps are higher now than they have been for some time.

Hugo Scott-Gall: Olga, my final question to you was really around where you started off. Falling interest rates in the U.S., should all else be equal, maybe see the dollar more likely weaken than strengthen, and in that scenario, do emerging markets, which have been really pretty much every asset class outside of the U.S. in the shadow of the mighty dollar and the sort of U.S. exceptionalism priced into things like U.S. risk assets, do you think that emerging markets can perform better versus recent history, and within that we didn’t talk about India.

Is India in many ways the poster child of what emerging markets should be in terms of its growth and GDP per capita, the expansion of consumption, the form, build-out of infrastructure? How are you talking about emerging markets overall, and maybe address my India question in the framing of where it is.

Olga Bitel: Well, that’s nice and broad. That topic, Hugo, could probably be a discussion, a podcast all unto itself. But I’ll try to be laconic. Look, broadly speaking, emerging markets, equities, as international equities more broadly do much better when the dollar is lower, or the rate of dollars to the various respective currencies is coming down rather than rising. And so, to the extent that we expect growth differentials and interest rate differentials, the two dominant drivers of the dollar’s appreciation in the last several years, going into a rearview mirror.

Both are obviously subject to change, but that’s our current expectation. The dominance or the appreciation of the dollar that we’ve seen should subside as well. And as that subsides that paves the way for better equities performance, both out of EM and international markets more broadly. And the reason for that is because lower dollar buoys their dollar-denominated earnings relative to everyone else. So, when you’re comparing earnings growth in a constant currency, lower, all else being equal, lower dollar means stronger dollar-denominated earnings across the board.

So, that’s the rationale for that, and that’s our expectation very broadly. There are a lot of bilateral nuances to that, but that argument certainly applies to Japan and some of the other developed economies as well. In terms of India more specifically, look, India has seen a tremendous gain and reaped tremendous gains, efficiency gains, from its monetary reform that it conducted in 2013. That was a massive structural reform that was probably underappreciated at the time.

And what it did was it disintermediated a lot of the middlemen from when the government in Delhi or wherever is trying to hand out cash payments to roughly 900 million or so people in India that still to this day rely on government subsidies for subsistence and can now do so directly with a direct deposit into their bank account, disintermediating loads of bureaucrats and intermediaries along the way. That results in significant improvement in efficiency.

That results in significant improvement in rural and urban consumption, and that results in what the next stage of government’s policy which have also been very successful, which is to then channel that aggregate small but significant savings back into their domestic capital markets so that they can undergo infrastructure spending and various other forms of capital improvement. So, we’re starting to see some of that pan out. But the liquidity surge that has been enabled by the efficiency gains from the monetary policy reform, unfortunately, so far, has masked as a strong rebound in GDP growth.

In terms of productivity growth in India, we are still looking for those. Those have not yet materialized. The infrastructure spending is picking up. Apart from infrastructure, investing, and private sector investment has been relatively lackluster, so the India story so far in the last decade and the decade to this day, has been much more about liquidity gains, about efficiency gains, and we’re starting to see a little bit on the infrastructure side. But the broad-based productivity gains and growth in GDP and aggregate and GDP per capita I think are still to come if you’re an optimist on India. But it hasn’t been the case so far.

Hugo Scott-Gall: Okay, well, look, I think have managed to talk about in broad terms where we think growth is going to be. We will wrap up this year, 2023, and look forward to 2024. So, I want to thank you both for coming on the show, and we look forward to next year. Let’s hope it all goes right.

Olga Bitel: Let’s all hope so. Thank you, guys.

Simon Fennell: Thanks so much.

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Hugo Scott-Gall, Partner

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