What Matters Now: The Comfort in Reducing Volatility

Everything’s Changed

We are heartbroken to see what the people of Ukraine are experiencing. The extraordinary leadership of President Zelensky and the bravery of the Ukrainian people in defending their homeland and families is inspiring people around the world. The defense of Ukraine is a vivid reminder of the high cost of freedom that many people enjoy but often take for granted.

“The war in Ukraine could not have come at a worse time for the global economy—when the recovery from the pandemic-induced contraction had begun to falter, inflation was surging, central banks in the world’s largest economies were gearing up to hike interest rates, and financial markets were gyrating over a formidable constellation of uncertainties.  The war has aggravated those uncertainties in ways that will reverberate across the world, harming the most vulnerable people in the most fragile places. It’s too soon to tell the degree to which the conflict will alter the global economic outlook… Much will depend on what happens next.” 

– Indermit Gill, Non-resident Senior Fellow at the World Bank excerpt from Brookings Institute, March 8, 2022

Everything changed on February 24th as war is being waged on European soil for the first time in decades. There will be no winners from this war as the damage already done has been far too great in terms of loss of life and destruction of a nation.  Unfortunately, the steepest economic price will be paid by the people of Ukraine and Russia followed by the world’s poorest nations and households that spend the highest share of their incomes on food and energy.  Besides higher prices, the fallout is likely to arrive through several other vectors: trade shocks, financial turbulence, flows of capital, and the flight of refugees.  The global economy will experience higher levels of inflation leading to slower global growth.

After being supported by historically low interest rates and highly accommodative policies, market participants who have grown accustomed to strong returns across asset classes must now recognize we have entered a new economic period where different investment opportunities are presented and invest accordingly.  With additional supply chain disruptions to food and energy being layered on top of the pandemic-related issues, the global economy is experiencing reduced monetary and fiscal policy support, higher levels of inflation and lower global growth.

The world is entering a period of massive geopolitical, economic, and societal shifts.  Russia’s attack on Ukraine will remake the world, but it is unclear at the present time just how much things will change as we do not know when or how the war will end.  What is clear, however, is that the global economy is facing another significant economic shock; the Ukrainian and Russian economies will likely be severely damaged for an extended period; Europeans will be facing significantly higher energy prices and greater prospects for a recession; the world food supply will be disrupted; global trade will undergo a significant makeover; national security has become a much bigger priority; and international alliances will be reconfigured.  Countries closest to the conflict—by virtue of their strong trade, financial, and migration links to Russia and Ukraine—are likely to suffer the greatest immediate harm. But the effects will be felt worldwide.

It is worth noting that since ARS Investment Partners was established in 1971, we have successfully navigated previous inflationary periods for our clients as well as several geopolitical conflicts during that time.  Our investment process, which combines both proprietary macro-economic analysis (top-down) and fundamental company research (bottom up), gives us an advantage in being able to invest in the secular themes to position ahead of shifts in capital flows as we have in recent years.  We began overweighting semiconductor and capital equipment companies, defense companies, Electric Vehicle  manufacturers and commodity producers essential for the clean-energy transition often well in advance of major market shifts.  We have employed the same investment philosophy and approach since our inception, and that approach has allowed us to successfully build and protect capital in challenging environments.  The most important consequence of the war in Ukraine is the lives lost and the humanitarian crisis associated with the huge numbers of besieged and displaced people.  This war represents a human tragedy of epic proportions with significant business, economic and geopolitical considerations as we describe in this Outlook.

Forces Driving Shifts in Capital Flows

“Sweeping and indiscriminate sanctions would only make people suffer. If further escalated, they could trigger serious crises in the global economy and trade, finance, energy, food, and industrial supply chains, crippling the already languishing world economy and causing irrevocable losses.”

-Excerpts from China’s Ministry of Foreign Affairs statement following the President’s Xi-Biden March 18th video conference call

As if fighting a global pandemic for the past two years was not enough, the world is now dealing with a ground war in Europe that has the potential to undo much of the progress made since the Berlin Wall came down in 1989.  In recent years, China and Russia have been seeking a rebalancing of the global order with the desire to reduce the military and economic influence of the United States and its allies. Autocratic nations have been spending heavily on developing their military capabilities.  The sanctions recently imposed on Russia were among the most severe issued in history and have already had a devastating effect on the Russian economy as shown in Chart 1.  As a result, our adversaries are considering new ways to mitigate the costs of future sanctions on their economies by establishing alternatives to existing Western-controlled systems such as SWIFT (Society for Worldwide Interbank Financial Telecommunication) banking system.  The sanctions are also causing nations and companies to reorient their supply chains and currency reserves to protect their economic interests against future actions by rival nations or blocs.  The remaking of the world order and the global economy is underway, and this may be the most meaningful change the world has experienced since WWII.

Chart 1. The Impact of Sanctions on the Russian Economy

Several forces are redefining the global economy.  First, global growth will be lower than previously projected.  Second, headline inflation will remain elevated as labor costs rise and energy and food supplies are being disrupted.  Third, the supply chain issues, which the world has been battling since the start of the pandemic and which had been starting to ease, are now being exacerbated by the war and the sanctions imposed on Russia by allied nations.  The combination of energy and food inflation combined with supply shortages and stockpiling will impact the most vulnerable countries, companies, and individuals.  Fourth, policymakers will increase or shift spending to improve national defense, space, cyber, food and energy security.  One additional issue that investors should consider is the intended and unintended consequences of the sanctions imposed by the West, particularly if the U.S. follows through on threats to add sanctions to China in the event that the Chinese help Russia.  The Russian economy is feeling the full effects of the initial sanctions as it has been forced to raise its benchmark policy rate to 20%, while its stock market and currency have been severely damaged.

Lower Global Growth

Gross Domestic Product for many countries was on pace to return to pre-COVID levels by the end of this year or next, but the war makes those projections unlikely to be achieved.  Prior to the invasion, global real gross domestic product was projected to grow around 3.4% due to the impact of inflation, reduced government stimulus, tighter monetary policies and ongoing supply chain issues which were only starting to be resolved.  The OECD recently released an update which projected world GDP to drop by 1.09% (see Chart 2).  Unfortunately, many emerging economies will be severely impacted by the combination of the lingering healthcare issues from the pandemic, high U.S. dollar-denominated debts, volatile commodity prices and availability, and erratic economic policies.  For the global economy, slower growth will mitigate some of the current inflationary pressures as demand declines.

Chart 2. The War’s Impact on Global Growth

Higher Inflation

Coming into the year, ARS believed that the economy would see its deflationary tendencies return in the second half of 2022 following the supply-driven inflation experienced due to the pandemic.  However, the war has added a new layer of complexity on to the inflation dynamics as Russia and Ukraine account for only 2% of GDP combined but have an outsized impact on the world’s energy and food supplies.  Russia, the 11th largest economy in the world, is one of the world’s leading exporters of oil, natural gas, nickel, aluminum, semi-finished iron, and wheat.  Europe, in particular Germany, is highly dependent on Russia for its energy needs.  Europe had been aggressively shifting away from fossil fuels to renewable energy but was still early in the transition when the war broke out.  The subsequent spike in oil and natural gas prices, as well as concerns about sanctions cutting off supplies to Europe, has governments scrambling to figure out ways to reduce the impact in the form of fuel subsidies, gas tax holidays, and fast-tracking permit approvals for energy companies to bring on additional production sooner.  The food problem may prove to be even more difficult to address as the world may lose a substantial portion of crops if Ukrainian farmers cannot meet this season’s planting deadlines.  Food inflation was one of the key issues leading to the Arab Spring over a decade ago.  Regardless of the actions taken by policymakers, the OECD projects that the war’s impact on inflation will range from increases of 1.36% for the U.S. to 2.47% for the world (see Chart 3).  While it is exceedingly difficult to make projections when the war’s duration and outcome is unknown, the world has clearly entered a period of higher prices.

Chart 3. The War’s Impact on Inflation

Interest Rates to Rise, But Must Remain Historically Low

The interest rate outlook calls for higher rates for the coming period as the Fed grapples with higher inflation arising from energy and food supply shortages as well as higher labor costs.  Since 2009, central bank policy has played an outsized role in supporting the markets and global economy as both struggled to recover first from the great financial crisis, then from the pandemic and now from the war.  Last year, central banks began tightening policy by raising benchmark policy rates, reducing quantitative easing, and signaling the end of the most extraordinary period in monetary policy history.  Central bankers are trying to balance curbing inflation by increasing rates just enough, while avoiding tipping the economy into recession. One of the challenges is that there is little central banks can do to offset inflationary pressures caused by supply disruptions beyond simply trying to reduce the level of aggregate demand, as their tools are designed to address inflation that results from excess demand.

Given the current state of the world’s economy, this interest rate hiking cycle may be quite different than previous ones as much of the world’s economy was still struggling to recover from the two previous crises.  Based on current conditions, it is likely that many countries will experience a recession sometime over the next 24 months.  We believe the Fed will prefer to continue to let inflation run higher than normal rather than cause a recession by hiking too aggressively.  Furthermore, the Fed will likely raise rates fewer times and to levels below what the Fed and market participants currently project, as the slowing global economy will naturally reduce demand and dampen inflationary pressures.  It is too soon to determine the full impact of the war on growth and inflation given the broad range of possible outcomes, and therefore, investors should expect the Fed and other central banks to be flexible in setting the course for policy actions.

Geopolitical and Political Forces

“It now seems likely that the world economy really will split into blocs, each attempting to insulate itself from and then diminish the influence of the other. With less economic interconnectedness, the world will see lower trend growth and less innovation. Domestic incumbent companies and industries will have more power to demand special protections. Altogether, the real returns on investments made by households and corporations will go down.”

-Economist Adam Posen, President of the Peterson Institute

For decades, globalization has brought the world closer together and raised living standards for billions of people, but it also created vulnerabilities for many domestic economies which have been brought to light in the past two years.  First the pandemic and then the war provided a painful reminder just how interconnected and interdependent the global economy had become.  The pandemic and the war in Ukraine underscored the over-reliance on autocratic nations in the global system for necessary resources including food, energy, commodities, and other basic materials.  The war in Europe is remaking the world order and alliances, and it is forcing world leaders to reassess their foreign and domestic policy priorities and dependencies in several key areas including national security (military, food, cyber and energy), the role of intergovernmental agencies such as NATO, WTO, and the UN, and how to properly affect the climate transition.  It is also forcing policymakers to reconsider budget priorities.  The severity of the sanctions placed on Russia by western governments has countries, including China, exploring ways to insulate their economies from future sanctions and to form new economic and defense alliances.  The United States and virtually every nation will now be focused on building up strategic reserves in a variety of essential materials required for the advancement of alternative energy sources, and critical defense needs and technologies.  The buildup of strategic reserves can increase the prices of these materials and keep them elevated for an extended period of time.

being forced to adjust spending priorities and policy around national security.  Given the need to increase spending in certain areas, President Biden’s Build Back Better agenda will likely be greatly reduced or not implemented at all.  Congress will likely be forced to rethink our energy policy, defense spending, and social spending priorities to deal with the new political and economic realities.  For China, the war has put the nation in a difficult position as it has close political ties to Russia, but much greater economic dependency on western nations.  As the world’s second largest economy and largest exporter, China will play an outsized role in how the political and economic issues get resolved. Europe will be facing several new challenges involving energy, defense, immigration, and resources while working to avoid a severe recession.  Some experts are suggesting that globalization has ended, but it will more likely shift to blocs whereby like-minded nations work to protect people and grow their economies in a changing world order.

Investment Opportunities for a Changing World

“The availability of ever-cheaper goods like cars, appliances and furniture produced abroad was a major contributor to the benign U.S. inflation picture in this quarter-century. On the other hand, offshoring also led to the elimination of millions of U.S. jobs, the hollowing out of the manufacturing regions and middle class of our country, and most likely the weakening of private-sector labor unions. The recognition of these negative aspects of globalization has now caused the pendulum to swing back toward local sourcing. Rather than the cheapest, easiest and greenest sources, there’ll probably be more of a premium put on the safest and surest.”

-Howard Marks, Oaktree Capital

Portfolio management is both an art and a science. It is a decision-making process that requires sifting through enormous amounts of incomplete information and making a judgment as to what is really important.  This is particularly true not only in a period of heightened uncertainty, conflict, and volatility such as we are in now, but also when the world is undergoing a fundamental change that is impacting virtually every industry.  Policymakers must address the growing cost of security due to the significant damage from climate change and the effects of war.  For much of the past decade, market participants had the wind at their backs and were able to be more aggressive than in normal times.  This was due to historically low interest and inflation rates which supported higher price-earnings multiples for companies with the promise of strong future growth, but the reality of little or no current earnings.  In a rising interest rate environment such as we are in today, price-earnings multiples have been and are contracting, and valuations are coming down.  While we did not anticipate rates to rise as much as they have this year, we were, for some time, of the belief that multiples would contract for those companies with elevated valuations and little if any current earnings.  As a consequence, in late 2020, we began to reduce positions and completely eliminate those companies whose valuations we felt were not sustainable.  We did this because the preservation of capital in pursuit of investment returns is both an offensive and a defensive process.

The dramatic shifts now taking place in the global economy will have profound implications for every country, company, and household, and these shifts are creating new investment opportunities, while reinforcing some previous ones.  There are two important factors to consider for portfolio positioning: first, the need for nations to reshore and expand onshore manufacturing capabilities critical to ensuring economic and national security, and second, the need to build up strategic reserves to protect future supplies of required resources.  Whereas just in-time inventory management had been considered an ideal way to manage manufacturing processes in the past, the pandemic and war have made “safe and sure” supplies in needed materials the priority over cost savings.  Advanced technologies will also allow companies to offset the former attraction of lower foreign manufacturing costs thereby creating many new jobs at home.

Aside from the opportunities described above, the focus for client portfolios remains consistent with our recent Outlooks as we continue to favor the beneficiaries of the digitalization and electrification involving cloud, cyber security, communications, semiconductor technology, industrials, healthcare, energy companies including wind and power, and commodity and materials producers.  Investors should continue to avoid over-hyped areas of the market, but also to be opportunistic to take advantage of the mispricing of quality companies that inevitably occur in volatile markets and uncertain periods.

We focus on the investment opportunities which meet our standards of valuation under these changed conditions.  We anticipate that companies will move more aggressively to improve productivity and better compete in the coming period through merger and acquisition activity and spinoffs.  Notwithstanding the significant advancements of many of the leading beneficiaries of this Outlook over the past few years, periods of market volatility should be viewed both as the pause that refreshes and an opportunity to add to quality companies with particularly attractive valuations which have significantly increased their revenues and earnings and continue to have bright prospects for strong growth.  Because the economy is undergoing a reorientation, the companies with embedded advantages will continue to fetch the best market valuations over time.  Security of critical raw materials is fundamental to successful investment outcomes. Continuing innovation and embracing the latest technologies will be fundamental for companies to remain at the forefront of competition.

Regardless, a number of leading companies, large and small, will continue to innovate, disrupt, and evolve their business models to thrive in the coming years.  As such, investors should be focused on benefiting from the powerful secular trends and not on speculating in shares of companies whose futures are behind them as they have either lost their way or will be unable to transition in their current forms to benefit going forward.

Published by the ARS Investment Policy Committee: Stephen Burke, Sean Lawless, Nitin Sacheti, Michael Schaenen, Andrew Schmeidler, Arnold Schmeidler, P. Ross Taylor.

The information and opinions in this report were prepared by ARS Investment Partners, LLC (“ARS”). Information, opinions and estimates contained in this report reflect a judgment at its original date and are subject to change. This report may contain forward-looking statements and projections that are based on our current beliefs and assumptions and on information currently available that we believe to be reasonable. However, such statements necessarily involve risks, uncertainties and assumptions, and prospective investors may not put undue reliance on any of these statements.

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As the Pandemic Matures, Different and More Equity Opportunities Emerge

The prospects for common stock investing are more positive than the headlines would lead market participants to believe because the investment opportunities are broadening.  The strong equity returns of the past few years should continue in 2022 for investors able to identify strong revenue and earnings growth in a slower growth environment and those undervalued companies that have been previously overlooked due to extreme concentration of investment in a relatively small number of pandemic beneficiaries.  Additionally, investment success will require navigating some subtle and some not-so-subtle shifts that are occurring in market leadership as the pandemic wanes.  Leading ARS to this more positive view is that the determinants of security valuation, namely the outlook for corporate profits, interest rates and inflation rates remain positive even with the elevated inflationary levels and higher cost of living experienced in the second half of 2021.  The world continues to undergo the transformations that ARS introduced to readers in our October 31, 2020 Outlook that define many of the most important investment opportunities.  These transformations will continue to shape the future of the global economy.

In addition to the impact these six transformations will have on the global economy, the United States’ post-pandemic economy will be shaped by the handoff from government spending to corporate and consumer spending as the primary drivers of growth in 2022 and beyond. Against the current economic backdrop, the areas that will attract capital in the new year will continue to be the beneficiaries of these transformations, particularly companies focused on cloud/data management and storage, semiconductor and capital equipment, broadband providers, select commodity producers, defense, biotech, cybersecurity, autonomous vehicles, gaming, and both renewable energy and fossil fuels.  ARS also continues to favor those companies with strong managements, steady earnings growth, and strong dividend policies as we project interest rates to remain range-bound near historically low levels for the foreseeable future.   Furthermore, investors should be focused on U.S. small cap companies which are selling at strikingly attractive valuations relative to larger capitalization companies in the S&P 500.

This Outlook will address the forces that are creating this favorable environment for equities, the risks that investors should consider for the coming period, and the investment implications with examples of businesses that our research has identified as particularly attractive on an absolute and relative basis.  Current conditions suggest that investors must look past the headlines and seek to identify those select companies that are particularly well-positioned to benefit from the secular trends that will drive global growth in a world economy that is undergoing a massive transformation, and one that has little or no historical precedent.   

Why is the ARS view more positive than the headlines are leading investors to believe?

Due to the highly unusual political, economic, and social dynamics present in the world today, the markets have been experiencing elevated levels of volatility.  However, the recent market pullback has created interesting opportunities in companies that are selling for highly attractive valuations. A recent report from JPMorgan highlighted the divergences between and within the indices, particularly the Russell 3000 and the NASDAQ.  The report stated “that outside of the Big 10 stocks in the US, equity drawdowns and multiple de-ratings have been severe. Russell 3000 was down only -4% and Nasdaq Composite -7% from 12-month highs, however, the average drawdown for constituents in these indices was -28% and -38%, respectively.”  A drawdown is the decline in a stock’s price from its recent highs.  In addition to the wide spread of returns within the indices, what some investors seem to be missing is how the sequencing of policy action is impacting the economy and markets.  For example, the Federal Reserve and other central banks acted in March 2020 to lower interest rates and re-instituted their quantitative easing programs (which increased the money supply) adding massive liquidity into the global system.  This in turn fueled the rise in valuations across a variety of assets including stocks, real estate, collectibles, and cryptocurrency. As consumer net worth has increased, this has led to improved consumer confidence which fueled consumer spending. For corporations, the effects of the pandemic and the rise in corporate earnings and cash flows are now fueling the ability to increase capital expenditures to improve productivity. The strength of the economy during the pandemic period has resulted in record profits for many companies which will help drive continued earnings and dividend growth and investments in people and productivity. 

First, the massive monetary and fiscal stimulus that has been implemented in the past 18 months will continue to provide favorable conditions for the next 18-24 months even after the Federal Reserve completes its tapering and begins to raise short-term interest rates. 

Second, the U.S. has experienced rapid growth in its money supply since March of 2020, and this has helped foster a surge in consumer net worth which, when combined with higher wages, supports and augments consumer spending and investment.   For perspective, the Federal Reserve’s balance sheet prior to the 2008 recession was around $975 billion and today is approximately $9 trillion, and other leading central banks also experienced similar increases in their balance sheets.  It is completely impractical for market participants to expect a dramatic reduction in central bank balance sheets anytime soon without engendering a huge global shock. 

Third, corporate profits will continue to hit record levels which will allow many to pay higher wages while investing in the productivity improvements necessary to increase earnings and remain competitive over the long term as they move to replace human labor with technology. 

Fourth, ARS believes that supply chain problems will continue to ease in 2022 which should reduce inflationary pressures, while onshoring and reshoring will further bolster domestic economic growth.

Finally, the global economy will continue to adjust to the issues related to COVID and should begin to return to more normal pre-pandemic levels as vaccination rates/herd immunity allow for reopening to take hold, barring the development of additional variants.  It is the cumulative effect of all these forces that will drive positive returns for equity investors.  In 2022, investors should focus on those companies with the ability to increase revenues, those with pricing power, with the ability to invest in improving productivity, and who can effectively manage their overall wage costs.  Market participants should be careful about their country exposures as debt, currency and health issues are exacerbating the divergences between the handful of advanced nations that are growing in a more sustainable fashion than the rest of the world.  In 2022, the United States should continue to be the primary driver of global economic growth.

What are the risks in the system?

With the rapid spread of the Omicron variant and vaccination challenges in much of the world, the most obvious risks are geopolitical, inflation, debt levels and pandemic-related disruptions including global supply chains.  The Scowcroft Center for Strategy and Security recently released a report entitled “The Top 12 Risks and Opportunities for 2022”.  The areas highlighted in the report are as follows:

1. The lack of effective COVID-19 vaccination in developing countries triggers new variants that are potentially more contagious and lethal. The report states that African nations have vaccinated only about 12% of the population as developed nations have not stepped up to provide sufficient supplies of vaccines.

2. Russia attacks Ukraine. This represents one of the biggest threats to global stability next year as Russian President Putin has poked and prodded the European nations over Ukraine and energy security. Mr. Putin has stated that “Russia and Ukraine are one people – a single whole.” 

3. As China peaks, its economy sputters – sparking global disruptions. The Chinese economy hit several speed bumps last year.  President Xi is positioning for a third term and as the leader for life, but the Chinese economy is experiencing some growth pains as evidenced by the debt problems of Evergrande and other companies in the real estate sector which represents 29% of the Chinese economy.  The government made examples of several companies including Alibaba, Tencent, Didi, and many in the for-profit education sector under its “common prosperity” initiative to address inequality and reinforce the party’s control of the nation.

4. Afghanistan collapses and the U.S. cannot escape the consequences. This nation faces a humanitarian crisis as the U.N. projects over 23 million Afghans faced imminent starvation and its banking system is in an uncertain state as the international community struggles to navigate prohibitions on aiding the Taliban. 

5. Developing countries suffer more severe economic troubles and a rash of political instability. The pandemic has carved out large numbers of the global middle class with more than 131 million more people in poverty.  Adding to the problems are widening inequality which fosters more political instability, potentially more civil strife and forced migration.  The strength of the U.S. dollar places further strains on developing economies to service high U.S. dollar debts. 

6. Oil tops $100 a barrel. The clean energy transition is proving more difficult to effect, and fossil fuels will remain a larger portion of global energy supply for longer than hoped after a period of underinvestment.  The supply issues combined with stronger than anticipated demand pushes prices higher.  The U.S. and other developed nations are in the hands of OPEC and Russia’s willingness to accommodate growing demand for fossil fuels.

7. The world fails to meet its climate goals from the inconclusive Glasgow summit. Global carbon emissions have grown 60% since the 1997 Kyoto Protocol was signed.  The Glasgow summit did little to inspire confidence that the world will achieve the necessary levels of carbon emissions in timely fashion.

8. A bifurcated world emerges, but it’s not a repeat of the cold war with Russia. The report highlights the differences in China’s political and economic strengths relative to where Russia was in the cold warChina’s global aspirations, importance as a growing consumer market, its long-term planning, overall economic strength, and position in the high-tech world are    just a few of the differences that need to be considered.

9. Food security worsens, propelled by COVID-19, climate change and conflict. The World Food Program estimates that 45 million people are on the brink of famine with higher food and transportation costs creating problems for families and organizations that provide support.

10. More countries slip from their current state into failure. While countries such as Syria, Yemen and Somalia are regularly at the top of the list of “very high risk” nations, these and other nations are moving closer to failed state status, if not there already, as drought, water scarcity, food crises, rising inequality, the pandemic and other healthcare issues are pushing nations to the brink.  Two major concerns stemming from this issue are the negative effects on others in the region and migration issues, which pose social, economic, and political issues for other nations, especially European ones.

11. Western efforts to revive the Iran Nuclear Deal fail. Iran is demanding that sanctions be lifted even as it continues to develop its nuclear program.  As involved nations continue to fight proxy wars and engage in cyber-attacks and other provocations, the probability for political missteps increases as does the potential for armed conflict.

12. U.S. democracy further decays. The report suggests that democracy will erode significantly next year in the U.S. which continues a trend that started a decade ago but was made crystal clear during the January 6th attack on Congress, something most Americans never thought they would see in their nation.    

In addition to the 12 risks listed above, inflation has become a concern for U.S. policymakers for the first time in decades.  In addition to supply chain issues pushing costs up, wages have been rising in the past few quarters with some unions, including workers at Deere and Kellogg, having negotiated big wage gains with cost-of-living adjustments (COLA) being included.  These cost-of-living adjustments bear watching as ARS has previously written that our team was more concerned about the wage bill (the total compensation costs for the company) as opposed to wage rate (how much individual workers are paid per hour).  Our view was based on the belief that productivity improvements would more than offset the higher hourly wages for many firms, however, the recent union wins on COLA will require investors to be more company-specific about its impact.

These risks are, for the most part, well known and well understood.  However, that does not mean that investors should not take note and invest accordingly as these factors and new ones will determine the appropriate positioning for portfolios. Interestingly, the authors did not list inflation as a top twelve risk.  ARS believes that after a period of elevated inflationary pressures, the deflationary tendencies that existed prior to the pandemic will re-emerge in the second half of 2022.  The four deflationary forces are globalization, which has been more inflation-prone since the onset of the pandemic, technological advances, which accelerated during the pandemic, debt, which continues to rise globally, and demographics, which continue to worsen.  

What are the investment implications of the Outlook?

For all the risks described above and other uncertainties, there are exciting opportunities as the global economy is undergoing a long-term revolution of digitalization and electrification.  Technology has been advancing at such a rapid pace that we are witnessing a massive reorientation of economic activity which is being further augmented by the necessity to address climate change with advanced technology that did not exist only a few years ago.  The conditions heading into 2022 are positive for equity markets as we expect strong earnings next year and the highly accommodative monetary environment to continue at least through next year.  However, investors must be selective as the potential for equity returns will be driven by absolute earnings and revenue growth rather than expectations of future growth, as it has been since the onset of the pandemic.  Taken in the aggregate, stronger corporate earnings, low interest rates and the gradual easing of inflationary pressures should continue to create favorable conditions for equity returns in 2022. 

The recently passed infrastructure bill in conjunction with increases in consumer and corporate spending are creating positive longer-term investment opportunities in a number of areas.  The following are quotes from an industry leader describing the sector dynamics and an example of an unnamed company in that industry that highlights the unique combination of a high-growth company selling at an attractive valuation. 

Semiconductors and Capital Equipment

What the leaders are saying – “The secular tailwinds around semis, everybody knows what it is. We all get excited about 5G, AI, automotive, all of the things you’ve heard everybody talk about for the last, I don’t know, 6, 9 months, are growing. Semi content is growing on top of that. Capital intensity is growing… And when you look at that, it just sets up to be what I think is a great industry.”

Stock Opportunity – One leading semiconductor company has revenues of $27.7 billion, holds more than 48,000 patents, does business in 17 countries, and has 11 manufacturing sites. It will invest more than $150 billion in leading edge memory manufacturing and research and development over the next decade. Total revenues have risen more than 33% year over year.  Data center revenues were up more than 70% year over year. The company projects “that automotive and industrial will be the fastest growing memory and storage markets over the next 10 years. New EVs are becoming like a data center on wheels, and we are already seeing examples of 2022 model year EVs supporting Level 3 autonomous capability with over 140 gigabytes of DRAM and also examples with over 1 terabyte of NAND.”  This company currently sells for less than 9x earnings and generates free cash flow to raise dividends and buy back stock.  This is an unusual opportunity when companies with much less growth sell for much higher valuations.

Commodity Companies

What the leaders are saying – “Underlying all of this is the fundamental outlook for copper is incredibly favorable. Copper’s role in the economy and as the economy changes with global investments in infrastructure – I know we have a controversy here – but countries around the world are going to build infrastructure. Less developed countries are going to develop. The world is getting increasingly focused on electrification with modern technology, 5G, and artificial intelligence. And then a new major element that people are talking about and recognizing now, for demand that’s coming, it’s not here in real significance now, is all the investments that people are going to be making to reduce carbon. And across the board, those investments are – result in significant demands for copper. And then you’ve got – and we’ll talk about this more, the commodity really supported by supply factors.”

Stock Opportunity – One leading company is selling for 10x earnings, an estimated 7.5x cash flow from operations with 27% return on capital and 42% return on equity.  The company has operating margins of 44% and a net profit margin of 25% with strong cash flows.  The company’s earnings and dividends are expected to grow double digits over the next few years.

Broadband Industry

What the leaders are saying – “As expected, we continue to see very high demand for data by our customers. During the quarter, non-video Internet customers used over 600 gigabytes per month, stable as of late, but more than 30% higher than pre-pandemic levels.  And today, close to 20% of our nonvideo Internet customers use a terabyte or more of data per month.”

Stock OpportunityOne leading company is selling for 12x forward cash earnings while growing earnings at 15% per year and spending all of free cash flow to buy back stock.  If the stock price were not to rise between now and 2025, the company could buy back 35% of shares outstanding and generate $110 in cash earnings per share on a $650 stock or 6x cash EPS. More realistically, should the multiple stay constant, the stock price should increase by 25-30%/year, in line with the free cash flow per share growth.

In a world that is rapidly changing, investors must recognize and appreciate the magnitude of the changes that will impact companies for many years.  It is easy to get thrown off course from a long-term investment plan by short-term factors, so be careful not to confuse speculation with investing.  Businesses that are proactively investing to redefine themselves will have a chance to compete,while those that do not will be left behind. To protect and build capital in this environment, investors should focus on the primary beneficiaries of critical secular themes in this period of significant disruption and avoid the companies that are being disrupted.  These secular themes include the continuation of technological advances and the powerful demographic shifts involving aging, automation, and inequality. Climate change has become a more actionable investment theme across all equity strategies. These themes will have profound implications for investment strategy.  Successful investing in the coming year will require a high level of conviction and insight at a time when many aspects of our lives could be experiencing significant change. 

We wish our clients and readers a happy, healthy and fulfilling New Year.

Published by the ARS Investment Policy Committee:

Stephen Burke, Sean Lawless, Nitin Sacheti, Michael Schaenen, Andrew Schmeidler, Arnold Schmeidler, P. Ross Taylor.

The information and opinions in this report were prepared by ARS Investment Partners, LLC (“ARS”). Information, opinions and estimates contained in this report reflect a judgment at its original date and are subject to change. This report may contain forward-looking statements and projections that are based on our current beliefs and assumptions and on information currently available that we believe to be reasonable. However, such statements necessarily involve risks, uncertainties and assumptions, and prospective investors may not put undue reliance on any of these statements.

ARS and its employees shall have no obligation to update or amend any information contained herein. The contents of this report do not constitute an offer or solicitation of any transaction in any securities referred to herein or investment advice to any person and ARS will not treat recipients as its customers by virtue of their receiving this report. ARS or its employees have or may have a long or short position or holding in the securities, options on securities, or other related investments mentioned herein.

This publication is being furnished to you for informational purposes and only on condition that it will not form a primary basis for any investment decision. These materials are based upon information generally available to the public from sources believed to be reliable. No representation is given with respect to their accuracy or completeness, and they may change without notice. ARS on its own behalf disclaims any and all liability relating to these materials, including, without limitation, any express or implied recommendations or warranties for statements or errors contained in, or omission from, these materials. The information and analyses contained herein are not intended as tax, legal or investment advice and may not be suitable for your specific circumstances. This report may not be sold or redistributed in whole or part without the prior written consent of ARS Investment Partners, LLC.


Looking At the World Through a Different Lens

While short-term investors are concerned about the political dysfunction in Washington D.C., the Delta variant slowing Gross Domestic Product (GDP) growth, the dramatic remake of the Chinese economy, ongoing supply chain disruptions, rising debt levels, and inflationary pressures, we believe they have been somewhat discounted by the markets, and there is a much bigger story to be told.  The American economy is using innovation, entrepreneurialism, and some thoughtful pro-growth government initiatives to position itself for the post-pandemic world.  Last month some of our team visited six Midwest cities and met with entrepreneurs, government officials, business, and community leaders as well as university students.  We walked away feeling excited about the potential for the United States in the post-pandemic period from both a market and economic perspective. ARS believes that investors should take advantage of the aforementioned fears to position their portfolios for the opportunities that lie ahead.

Excessive focus on near-term concerns often distracts from the sub-set of companies that stand to benefit from the current environment, especially those experiencing price inelasticity of demand for their products.  An important fundamental concept for investors to understand in the coming period, price inelasticity reflects goods that typically tend to have few substitutes, few competitors and are considered necessities by users.  Given the current supply-chain woes and inflationary pressures, the ability of companies to offset any increase in production costs will enable them to increase earnings and cash flow from operations and should be worth more over time.  Among the areas of investment opportunity where there is inelastic demand are semiconductor chips and equipment, cloud providers, select commodities producers including steel, rare earth materials, copper and even some fossil fuel producers as each should continue to see strong pricing power, demand, and earnings growth.  This point cannot be over-emphasized.    

We continue to view the United States as the best market on a risk/reward basis due in large part to our nation’s innovative and entrepreneurial spirit despite recent hang-ups in D.C. Larger amounts of money than ever before are being invested in the transformation of the economy.  This will continue to generate greater productivity, record earning power and greater tax revenues for the United States over time and will also reduce inflationary pressures which have developed as a consequence of the pandemic.  Because the profound transformations occurring will continue to be the defining themes for the markets and the economy, positive investment returns should be a consequence of the focus on the digital, monetary, fiscal, healthcare and climate transformations that support productivity improvements and rising living standards which will offset the potential for long-term inflation from taking hold.  Under present conditions, we define the companies for our research focus that will be among the specific beneficiaries of the forces we describe below. 

In a world awash in liquidity, asset values will continue to benefit from accommodative monetary policy initiatives and an interest rate structure that has never been so low. Corporations have unit labor costs rising at the same time the marginal cost of capital is at such low rates allowing for technology substitutions to be executed to lower costs over time.  We are investing in greater efficiencies in the economy.  The initial pandemic lockdowns and the subsequent challenges in reopening the global economy have led to significant pricing pressures in the near term, but we anticipate that the logistics logjam will clear suddenly and that these short-term pricing pressures will evaporate.  While we are experiencing short-term inflationary pressures, investors should not assume that these pressures must lead to a longer-term inflation problem.  Our research continues to identify companies with the potential to increase earnings, assets, and cash flows against this backdrop.  There must be a particular emphasis on those companies driving the digital transformation as technology producers or users require these productivity improvements to thrive in the post-pandemic world.

Remembering What Makes the United States Special

Americans live in an amazing country, one that is flawed as our elected officials in Washington continue to remind us, but also one where people can accomplish things through innovation and hard work that were once unimaginable as demonstrated by the creation of two highly effective vaccines in less than 18 months.  As the chart below from Zbigniew Brzezinski’s 2003 book Strategic Vision highlights, the United States has its share of short comings, but it is a highly resilient and adaptable nation with some unique strengths that we need to continue to build on.  We have a system based on the rule of law with the deepest and most mature capital markets system in the world.  It is this capital market system that funds the growth and innovation that continues to raise living standards for so many.  While we share similar demographic challenges with many other leading nations, the United States remains an attractive destination for many immigrants looking to better their lives.  If we do not squander the opportunity to attract and retain highly skilled talent from around the world, then we will continue to be one of, if not the leading economic powers for many years to come.

Table 1. America’s Balance Sheet

To accomplish this, the United States must remain competitive from a tax, infrastructure, immigration, and business-friendly perspective as well as maintain the dollar’s reserve currency status.  Yes, we must address inequality, climate change, and other key issues, but we need smart policies that bring people together rather than divide them.  Our nation is at its best when we come together to help each other as we did after the 9/11 attacks and not when we are divided as we are today.  We need true leaders and principled officials focused on the best outcome for our nation, rather than ideologues.  The strength of the United States going forward will be determined in large part by our overall economic strength, our ability to remain technology and innovation leaders, to use our democratic appeal and practical immigration policies to offset our demographic challenges, and by our ability to put partisanship aside for the greater good as the challenges are significant, but so is our ability to solve them.    

Exciting Stories from the American Midwest

As mentioned above, we visited Chicago, Detroit, Ann Arbor, Cincinnati, Columbus, and Cleveland in September and met with senior government officials, business leaders, entrepreneurs, students, and other investors.   The trip served as an important reminder of what is really going on in our states and cities and told a story of innovation, entrepreneurial spirit and how government can plan beyond an election cycle to put a state or city on track for sustainable growth.   There are great success stories in each city: however, for the purpose of this Outlook, we will focus on an organization called JobsOhio, and how two Ohio-based companies are driving innovation – Cintrifuse in Cincinnati and Nottingham Spirk in Cleveland.   Anyone meeting leaders at JobsOhio, Cintrifuse and Nottingham Spirk could not help but come away with a completely different perspective on the state of our nation than one would get from the daily news headlines.  These leaders see problems as opportunities waiting for a solution.

JobsOhio

In the aftermath of the Great Financial Crisis, Ohio was faced with double-digit unemployment and had lost 400,000 jobs.  Leaders knew something had to be done as businesses were leaving the state which then ranked 48th in its prospects for growth and job creation.  Then in 2011, leadership decided to launch JobsOhio, a private nonprofit corporation designed to drive job creation and new capital investment in Ohio through business attraction, retention, and expansion efforts.  Unlike other economic development organizations, JobsOhio has a unique funding model in that it uses no tax dollars or other public dollars to support it.  Rather it uses revenues from the JobsOhio Beverage System (JOBS) to which it leased the rights for 25 years.  The organization’s design enables it to make the kind of long-term investments needed to solve complex challenges such as supporting the development of new cutting-edge industries and businesses to serve new large total addressable markets.  JobsOhio focuses on supporting high- value industries including advanced manufacturing, aerospace and aviation, automotive, autonomous mobility, energy and chemicals, financial services, food and agribusiness, healthcare, logistics and distribution, military, and technology.   Ironically, this list of industries closely matches the “strategically vital” industries the Chinese government highlighted in its “Made in China 2025” 5-year plan.  Because of the funding source, industry focus and thoughtful design, JobsOhio should be closely looked at by other states as a model to attract and retain businesses and keep young talent at home.  Corporate America is taking notice as companies including Amgen, AWS, First Solar, Google, Peloton, Sarepta Therapeutics, Ultium Cells, and Upstart, among others, have all made recent major investments in Ohio.

Nottingham Spirk and Cintrifuse

In Cleveland, a visit to the beautiful 60,000 square foot facility of the Nottingham Spirk Innovation Center In Cleveland, a visit to the beautiful 60,000 square foot facility of the Nottingham Spirk Innovation Center highlighted a firm at the cutting edge of disruptive innovation and one that is inventing and improving many of the healthcare and consumer products we use every day.  Nottingham Spirk is an open innovation and product development firm that was established in 1972.  It uses the latest technologies such as 3D printing to design, test and develop its products, and its approach has significantly reduced the time and cost to bring new products to market.  Nottingham Spirk uses vertical integration in its facility where the entire product development cycle – from focus group facilitation to product design and mechanical engineering – is executed. Cincinnati-based Cintrifuse has one goal which is “to make Greater Cincinnati the number one tech start-up hub in the Midwest and among the most attractive innovation hubs in our nation.” Cintrifuse’s approach leverages its venture fund to access cutting edge technologies, generate strong financial returns and create investment pools for entrepreneurs; to connect the region’s largest corporations with the innovations and innovators they need to stay ahead of their peers; and they work with entrepreneurs to start new businesses and connect them with leading corporations in the area.  According to its website, Cintrifuse has over 600 startups in the pipeline half of which are attracting seed and later stage investments. 

By partnering with firms like JobsOhio, Nottingham Spirk and Cintrifuse, companies have access to unique industry insights, design, and manufacturing expertise as well as marketing and branding support.  While we are highlighting just these initiatives in Ohio, there are many other organizations like these around the country including Ben Franklin Technologies of NE Pennsylvania which has helped launch many companies, create new products and markets, and to develop cutting-edge innovations and create jobs.  Finally, we would recommend spending some time listening to college students discuss their hopes, dreams, and concerns if you want an optimistic view of the future as our nation turns out some of the world’s finest students.  When we combine strong leadership and innovation with talent and supportive government programs and policies, then there is virtually nothing that the American economic engine cannot achieBy partnering with firms like JobsOhio, Nottingham Spirk and Cintrifuse, companies have access to unique industry insights, design, and manufacturing expertise as well as marketing and branding support.  While we are highlighting just these initiatives in Ohio, there are many other organizations like these around the country including Ben Franklin Technologies of NE Pennsylvania which has helped launch many companies, create new products and markets, and to develop cutting-edge innovations and create jobs.  Finally, we would recommend spending some time listening to college students discuss their hopes, dreams, and concerns if you want an optimistic view of the future as our nation turns out some of the world’s finest students.  When we combine strong leadership and innovation with talent and supportive government programs and policies, then there is virtually nothing that the American economic engine cannot achieve.  

The Climate Transformation and the Challenge of Getting There

“The climate crisis is real, and energy transition is a necessity, and we must accelerate it — but it’s not a flick of a switch.  If we want to solve climate change, we need to do so while at the same time insulating the global economy from extreme energy shocks.”

– Amos Hochstein, U.S.’s top energy diplomat

It is easy to get broad support for reducing the world’s dependence on fossil fuels but wanting to effect a transition and actually doing so are two very different things.  This is especially true when we are still in the early stages of developing the green energy industry.  Cost and infrastructure remain significant hurdles.  It has been estimated that even if all the Paris Accord pledges were met, oil and gas would still be 46% of the world’s energy supply in 2040.  It seems that climate activists wanted to address years of neglect in a shorter period than is feasible, and we are currently experiencing energy issues in the United Kingdom, Europe, China, and India just to name a few countries.  For the United States, the green transition comes just a few years after the U.S. achieved energy independence once again.  As opposed to China which relies on imports of oil and natural gas for much of its energy needs and will be slower than other leading nations to make the transition; and the Chinese are also increasing their coal production this year as they are experiencing severe power outages.  As shown in Chart 1, fossil fuels will be key components of the energy supply for the foreseeable future.  Rather than vilify the industry, green energy proponents should be focusing on working to ensure an effective transition.  In fact, the major oil companies are diverting tens of billions of dollars of their excess cash flows from high-cost exploration and development to research into cleaner energy technologies.  From a geopolitical perspective, the rush to make the climate transition has empowered Russia and OPEC to be the price setters as the U.S. producers will not invest in high-cost exploration and development.  This has been the single most important determinant of the share prices of U.S. energy producers this year in the S&P 500.

Chart 1. Projected Growth in Energy Demand by Fuel Type – 2020-2045

In our view, there are three key considerations regarding the energy transition.  The first is that the power grid systems will need to be upgraded, hardened, and modernized to deal with the increased demand, extreme climate events, and new energy use patterns.  The second is that oil companies, in response to public pressure and shareholder activists, have been reducing their capital expenditure programs and drilling rig counts which are exacerbating a supply/demand imbalance that has led to higher-than-expected oil and gas prices.  The third consideration is that success in expanding the use of green energy, especially for electric vehicles, will increase electricity consumption and timing of its usage.  This begs the question as to how we produce that electricity and store and transport new renewable energy?  Perhaps the most important question is how do we affect the transition without damaging growth prospects and fueling inflationary pressures?  And how do we do it with an aging and antiquated grid system in the United States?  Climate activists will need to embrace one challenging concept: the green energy transition will be powered in large part by fossil fuels which are experiencing reduced investment spending and lack of support from equity and bond investors.  At a less than 3% weight in the S&P 500, the energy sector is one that will likely see its weighting increase in the coming period as it did back in the late 1970’s and the early 2000’s when each time its weighting more than doubled. One must wonder if the power problems being experienced around the world today are a precursor to our future energy transition challenges.  After the pandemic, the climate transformation may be the most important scientific and political challenge for the rest of the century.

Investment Implications

Since the onset of the pandemic, market participants have been faced with an investing environment that is simply unlike any other mainly due to the unique character of the health situation, inflationary/deflationary forces, and technological advances.  This is not an economy we’ve ever seen.  While rising costs have led many investors to have a stronger inflationary bias, the view that more inflation is here to stay is not supported by investment activities occurring to substitute capital for labor (robotics and artificial intelligence), advances in manufacturing efficiency, and mergers and acquisition transactions to promote greater business activity and lower production costs. Infrastructure spending raises productivity and saves costs that would otherwise occur by avoiding needed repairs, restoration, and damage from climate change.  Additionally, modernization of old infrastructure which yields better employment outcomes and higher living standards, by definition, is needed by the United States to better compete globally.  Many of the inflationary concerns seem to ignore secular deflationary pressures that are a characteristic of the hidden forces at work.  These include the demographic pressures from an ageing work force, overall debt levels in the system, lower costs thru technology improvements and breakthroughs, and communication advances.  Solving the short-term supply chain and logistic bottlenecks will rapidly lower inflation expectations.

With respect to manufacturing, just-in-time inventory management had been considered to be an ideal way to manage manufacturing processes for many years.  However, the recent experience of U.S. businesses running with low inventory levels has come to damage the economy, and therefore has been an impediment to lowering costs.  Present economic conditions are accelerating the reshoring and onshoring of critical manufacturing capabilities drawing capital back from overseas as well as utilizing excess liquidity in the United States.  Because the economy is awash in liquidity, there is no shortage of investment capital to fund critical initiatives.  In the 3rd quarter alone, corporations completed a record $1.6 trillion in mergers and acquisitions transactions globally.  Industries are rapidly being digitized.  This yields higher living standards, new products, large new total addressable markets, and ways of doing business that had never existed before.  We expect this economy to continue to produce outsized breakthroughs in products and services.  Irrespective of the timing and amount of proposed fiscal policy initiatives, monetary policy must remain accommodative with interest rates needing to be kept low for longer even after the tapering of quantitative easing begins later this year or early next year.

In addition to the above, there are several key investment considerations which investors should incorporate into their investment strategy that we address below:

Price inelasticity – In the current environment, market participants should focus on those companies that are well-positioned to benefit from price inelasticity. These include companies involved with the infrastructure buildout; producers of copper, iron ore, steel, and rare earths; technology companies including cloud service providers; businesses involved in the green energy transition; and certain defense companies to name a few. Importantly, these companies should be strong market performers in the coming quarters irrespective of the economic cycle.  

The Character of the Inflation Cycle – Perhaps the most widely debated topic at present is the state of inflation around the world as to whether or not it will be persistent or transitory.  Our expectation is a little of both with inflation more persistent for longer than we originally anticipated and then transitory with the surprise being a possible faster easing of supply chain problems than the market currently anticipates which would ease inflationary pressures quickly in certain areas.  While we see this as positive for the U.S., many emerging market economies are experiencing greater inflation pressures and their currencies will be more negatively impacted as will those nations dependent on imports of high-cost fossil fuels during the green transition.

Opportunity to Improve the State of Health Care – Unlike past business cycles, the United States needs a remake of its healthcare system, and we need to use technology to make healthcare more accessible, affordable, and adaptable to changing conditions such as future pandemics. The use of telemedicine, artificial intelligence, and data management to make our healthcare system more productive and efficient will help change economic output for the better, improve workforce demographics allowing workers to work more productively and potentially have longer careers as life expectancies continue to rise; and the combination of these should lead to increased future earnings for workers.  We also need to recognize that the pandemic requires a global solution as one recent report indicated that 96% of people in low-income countries are still unvaccinated which will lead to highly divergent economic outcomes with potentially large geopolitical considerations.  This is important because many leading scientists expect that pandemics may be more frequent in the future, so having a plan that would deliver better outcomes will benefit all. We continue to participate or take investment advantages of the convergence of technology with legacy industries through our cloud and software exposures.

Record Levels of Excess Cash Flows – The private sector has never had such high levels of cash flows available for investment and distribution to shareholders.  This will allow companies to raise wages, invest to improve productivity, to reshape their businesses to focus on high-return, high-growth business lines through mergers and acquisitions, but also allow for greater returns to shareholders in the form of dividends and buybacks.

Disintermediation of Businesses – Another characteristic of this environment is the disintermediation of businesses by new non-traditional competitors much of which is being driven by new technologies which companies are adapting at a much faster rate than in the pre-pandemic period. In fact, McKinsey recently reported that in 2020 “half of the North American and European businesses surveyed had increased their investments in new technologies and 75% planned to accelerate these investments between 2020-2024.”  Another interesting note from this report was that “companies digitized activities 20-25 times faster than they had previously thought possible.”  Technologies have the ability to disintermediate many businesses in the banking, insurance, and housing industries to name a few, and much of this disruption will be highly damaging to incumbents.  By following the capital expenditure plans of companies, investors can gain some insight into the future risks and opportunities of businesses.

Politics and Investing – Some politicians are viewing the pandemic as a chance to fix all historic ills and inequities which is admirable but needs to be matched with realistic and sound policies backed by good economic thinking.  From antitrust cases to tax and vaccination policies, there are major issues that require strong, thoughtful leadership focused on the best outcomes and not the most short-term politically expedient ones.  Another political problem is that the approach of governments to address climate change is actually helping the fossil fuel industry, but more concerning is that it is helping bad-actor, fossil fuel producing states such as Russia and Iran to benefit from higher prices and demand for oil and natural gas, including those products sold on the black market.    

The diverse needs of the nations and economies will favor those companies that (i) can lower costs and increase productivity, (ii) have strong global franchises with meaningful barriers to entry, (iii) benefit from resource scarcity, and (iv) have rising demand.  In our view, the best investment approach will be to focus on the intermediate beneficiaries of the conditions described in this outlook.  When the pandemic first started, we wrote that generally things would get worse before they would get better, and they did. Then conditions worsened again with each new wave of the virus.  This volatility has created negativity in the markets with many investors fearing a major pullback.  While that is always a consideration, we believe that investors will be well rewarded by taking a longer-term view, balancing return expectations with realistic risk assessments and taking a somewhat contrarian view to find uncommon values in a market with big divergences between the corporate haves and have-nots.  Fortunately, the next two decades should bring about more technology disruption than even occurred during the past two decades creating dramatic and timely improvements in productivity, health outcomes, economic growth, and accordingly improved living standards.  The journey is always a little bumpy, but patient and opportunistic investors will be well rewarded.

Published by the ARS Investment Policy Committee:
Stephen Burke, Sean Lawless, Nitin Sacheti, Michael Schaenen, Andrew Schmeidler, Arnold Schmeidler, P. Ross Taylor.

The information and opinions in this report were prepared by ARS Investment Partners, LLC (“ARS”).  Information, opinions and estimates contained in this report reflect a judgment at its original date and are subject to change. This report may contain forward-looking statements and projections that are based on our current beliefs and assumptions and on information currently available that we believe to be reasonable. However, such statements necessarily involve risks, uncertainties and assumptions, and prospective investors may not put undue reliance on any of these statements.

ARS and its employees shall have no obligation to update or amend any information contained herein.  The contents of this report do not constitute an offer or solicitation of any transaction in any securities referred to herein or investment advice to any person and ARS will not treat recipients as its customers by virtue of their receiving this report.  ARS or its employees have or may have a long or short position or holding in the securities, options on securities, or other related investments mentioned herein. 

ARS and its employees shall have no obligation to update or amend any information contained herein.  The contents of this report do not constitute an offer or solicitation of any transaction in any securities referred to herein or investment advice to any person and ARS will not treat recipients as its customers by virtue of their receiving this report.  ARS or its employees have or may have a long or short position or holding in the securities, options on securities, or other related investments mentioned herein. 

This publication is being furnished to you for informational purposes and only on condition that it will not form a primary basis for any investment decision.  These materials are based upon information generally available to the public from sources believed to be reliable.  No representation is given with respect to their accuracy or completeness, and they may change without notice.  ARS on its own behalf disclaims any and all liability relating to these materials, including, without limitation, any express or implied recommendations or warranties for statements or errors contained in, or omission from, these materials.  The information and analyses contained herein are not intended as tax, legal or investment advice and may not be suitable for your specific circumstances. This report may not be sold or redistributed in whole or part without the prior written consent of ARS Investment Partners, LLC.

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