3 investment themes worth backing in 2022
Battery market consolidation
Looking back at 2019, we initiated coverage on the battery metals sector and mentioned at the time the market had reached an inflection point. We noted that ‘Recently, an inflection point has been reached on the demand side. Investors have become extremely bullish on Tesla’s electric vehicle and battery market demand forecast’. We saw a market that went from being over-supplied with key battery components, to a market that was expected to be undersupplied over the next 5 years.
Two years later, we have seen the demand for these key components continue to accelerate, even as additional supply is brought to market. This is benefiting the companies that are producing these raw materials, Syrah Resources, Pilbara Minerals, Lynas Rare Earths, and Allkem, have risen by 246%, 1038%, 322%, and 230% respectively, from the 1st of January 2020 to the 24th of December 2021.
In our view, the next stage of this secular theme is the consolidation and integration, both vertically and/or horizontally, across the supply chain. We have already seen this with a merger between Galaxy Resources and Orecobre (now named Allkem). This merger improves their production capacity, allows them to gain market share, and at the same time, ideally improves their profit margins.
This theme can be further demonstrated by the recent agreement between Syrah Resources and Tesla Inc. They announced an offtake agreement with Tesla Inc to supply natural graphite from its vertically integrated production facility in the USA. This agreement locks in a price and the materials for Tesla Inc, and production capacity for Syrah Resources.
We expect that there will be further consolidation within the battery material producer and explorer space. In our view, it is prudent for the larger and more established companies, to acquire junior explorers with significant deposits. Also, a focus on acquiring other businesses that may operate within different parts of the supply chain, battery production facilities for example can be good business.
Mid-cycle bull market
As economies recovered from the initial shock of COVID-19 in February 2020, global central banks and governments attempted to reflate their economies, which we believe they have managed to do. Now that economies have moved past the initial reflation phase of the current market cycle, we now focus on the next stage of the bull market. In our view, this stage can be defined as mid-cycle.
This is essentially where policy-makers are restraining stimulus, the earnings cycle has picked up, demand is slowly rising (independent of policy), and economies are growing at above trend.
Historically, when equity markets are within the mid-cycle, we see mid to high single-digit growth for equity markets (in 2016, the S&P 500 rose ~12%).
Currently, the US Federal Reserve is restraining stimulus, by reducing their asset purchases by $30bn a month, with an expected end date early-to-mid 2022. After the wind-down of their monthly asset purchases, they have communicated to the market that they may look at lifting interest rates after that time, however it is data-dependent.
This phase of the market cycle can be challenging to manoeuvre, as on the horizon is the late cycle stage. Generally, this is when policy makers surprise on the tighter side to restrain demand significantly. Equity markets generally underperform during that period.Investors should focus on a pivot in policy from central banks which may be ahead of current market expectations. This pivot may indicate we are entering the final stage.
In our ‘2021 Themes’ document, one of our ‘tactical’ themes was an inflation spike. We continued to cover its development over the course of the year in issues 2 and 10 of ‘In the Frame’ and it is now back as a main theme for 2022.
2021 saw sustained supply chain bottlenecks combined with elevated consumer demand and wage growth to fuel inflation to levels not seen since the 1980s. The CPI in the United States is now running at 6.8%, with the United Kingdom at 5.1% and Australia trailing at 3%. As gas shortages hit Europe, UK CPI numbers are expected to continue to rise. Australia on the other hand is comparatively behind, however the most recent CPI figures hail from a quarter Sydney and Melbourne spent in lockdown.
The battle for 2022 will be how global central banks decide to deal with inflation. Most seem content to push the inflationary envelope to ensure the economy is strong enough to withstand an increase in interest rates. The Federal Reserve has begun tapering, however, continues to reinforce that interest rate increases are disconnected from their tapering timeline. The Reserve Bank of Australia will re-evaluate their bond purchase program in the February meeting, however, have indicated they do not see the economic conditions necessary for a rate hike materialising until 2023/2024.
With this in mind, we believe we will see inflation remain at elevated levels in the United States and continue to increase in Australia and the United Kingdom. If this occurs and central banks sit on their hands, inflation will pose a real threat to the continued economic recovery in 2022.
Consumer purchasing power will deteriorate, which would result in money being withdrawn from markets as the cost of living rises and wages lag. We will continue to closely monitor consumer and producer prices, as well as central bank rhetoric over the next 12 months.
There are a variety of options when positioning a portfolio for a high inflation environment. Real estate assets generally hold their value as rental income typically keeps pace with inflation. Investing in REITs (Real Estate Investment Trusts) can be a good way to get exposure to the property market without needing excessive amounts of capital.
Commodity markets also tend to outperform in an inflationary environment. This is because increased demand for goods flows down the supply chain and causes price rises in base production materials like copper and oil. Investments in listed copper and energy companies may be a good way to get exposure to this trade.
Within the original version of 'Investment themes worth backing in 2022', we include three tactical themes worth monitoring.
They can be found here: (VIEW LINK)
4 stocks mentioned