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Technology and inflation: focus on productivity

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The sudden and rapid return of inflation has not only made daily living more expensive, it has dramatically increased the cost of doing business. Businesses in all sectors are now facing record high energy prices as well as higher costs for labour, supplies and services.

This shift is driving historic investments in services and technology that can mitigate the effects of inflation, and that’s good news for businesses focused on increasing productivity. As companies invest more capital to bolster profit margins, analysts at Morgan Stanley Research see an investment opportunity in companies producing technologies that increase productivity, particularly in automation and digitalization, where barriers at the entrance are high.

“With infrastructure now at the forefront of the political landscape and the cost of labor and capital rising, business investment is likely to pivot towards improving productivity and technologies that can lower the cost of doing business,” says Josh Pokrzywinski, US Electrical Equipment. and cross-industry analyst at Morgan Stanley Research. “We believe that companies that provide innovative and cost-effective solutions will see increased demand and greater competitive advantages in their respective industries.”

While technology has had a profound cost-cutting influence for many years, its impact has been overshadowed by decades-long deflation driven by the overriding factors of slower population growth and manufacturing globalized. But that narrative has been upended by COVID-induced supply chain bottlenecks, rising geopolitical tensions and heightened focus on energy security. This change in circumstances should lead companies to prioritize spending that will help increase productivity, reduce costs and improve profitability.

In the United States, the average age of private fixed assets, such as property, plant and equipment, is at its highest level since the 1950s, which has contributed to a 20-year decline in the growth of the productivity. But the historic underinvestment in improving productivity underscores the value of automation and digitalization, especially in a context where the government is once again emphasizing investment in infrastructure, rather than lower interest rates and deficit reduction.

“All in all, we believe the incentives are now in place for organizations to refocus their efforts on automation and productivity-enhancing technologies,” says Pokrzywinski. “Companies that can provide such solutions to customers are more likely to take advantage of the higher prices and more volatile economic environment we expect over the next decade, providing a relatively attractive risk-reward investment proposition. “

Companies that help their customers increase productivity and reduce costs through automation, efficiency, or their own declining cost curves, while maintaining strong barriers to entry – what analysts at Morgan Stanley call “deflation facilitators” – make attractive investments in an inflationary environment.

Prior to the pandemic, the valuations of these deflation catalysts were mostly in line with the MSCI World Index, which tracks large- and mid-cap companies in developed markets. These companies saw a rise in valuation that continued until the end of 2021, but this trend reversed at the start of this year. Recently, companies identified as providing technologies and services to reduce costs and increase efficiency are trading at a discount to the broader market.

Companies that help fight inflation appear undervalued.

There are three major technologies, which affect the majority of sectors and are at long-term inflection points, which stand out as catalysts for deflation: artificial intelligence, clean energy and mass energy storage. and mobility.

Artificial intelligence
AI models are improving faster than predicted by conventional models, thanks to cheaper and increasingly powerful computational capabilities. The biotechnology sector, for example, uses machine learning and AI to discover new drugs cheaply, quickly and efficiently. Morgan Stanley believes this trend could lead to dozens of new therapies, potentially creating a $50 billion market over the next decade. AI could have a similar transformative impact in other industries, and as many companies are currently undervalued relative to the broader market, represents an opportunity for investors.

Clean energy
The transition away from fossil fuels will be a long and delicate balance, complicated by geopolitics, climate change and increased attention to energy security, and is ultimately expected to be highly inflationary. Morgan Stanley believes that companies with unique clean energy technologies and few competitors will be able to improve their profit margins through increased investment, thereby providing better value for investors. Many cleantech stocks don’t fit into a strong growth picture, and analysts recommend investors focus on companies benefiting from the widening gap between high utility bills and falling prices. clean energy costs.

Mass energy storage

Cheaper, widely available battery storage could transform a number of industries. For example, long-haul and heavy trucking has been under severe pressure due to high labor and fuel costs and labor shortages; a transition to battery-powered vehicles could reduce costs and help offset those costs. Advances in mass energy storage are also expected to contribute to the development of electric vehicles and, eventually, autonomous vehicles. Currently, battery technology is far from reaching its full potential, and investors need to ensure that the total addressable market for companies in the space grows significantly as technologies become cheaper and more of end users are able to use their products and services to reduce costs. .

While AI, clean energy, and mass energy storage are broad categories of technologies that combat the effects of inflation, they are not the only ones. Other technologies meet the needs of specific industries. “These range in form and function from automation tools designed to reduce the increasingly expensive workforce in organizations, to cost-effective reservation software for airlines that must find ever more innovative ways to offset the rising kerosene prices,” says Pokrzywinski.

For other investment opportunities amid expected prolonged inflation, Morgan Stanley analysts say investors should consider a wide range of companies providing services that use automation technology, such as robotics used in manufacturing, software to optimize business processes, and hardware for things like self-checkout. technology — to help clients manage the current inflationary environment.

For more Morgan Stanley research on technologies that can combat the effects of inflation, ask your Morgan Stanley representative or Financial Advisor for the full report, “The Deflation Enablers” (July 20, 2022). Morgan Stanley Research clients can directly access the report here. And more Ideas opinion leaders from Morgan Stanley.