The durable growers helping the world "cheat nature"
Note: This interview was recorded on Wednesday 1 May 2024.
Timecodes
- 0:00 - Intro
- 0:30 - Key lessons from several years of volatile markets
- 1:40 - Why the market will be very different over the next decade
- 3:10 - What makes Bates' investment process unique
- 4:37 - Why AI momentum is sustainable
- 8:07 - How Bates is invested in the AI thematic
- 9:31 - Innovations in healthcare - and why GLP-1s are a game changer
- 12:01 - Deglobalisation, reshoring and why this is an opportunity
- 14:40 - Durable growers and why Danaher (NYSE: DHR) makes the cut
These days, it feels like we are living in an episode of Netflix's dystopian future series Black Mirror.
Want to lose weight? Move over exercise and dieting, there's now a prescription drug for that. Want to write code, summarise large documents or browse the entire web for an answer in seconds? There are now large language models that can do that for you.
As T. Rowe Price's Peter Bates ponders, it almost feels like we are cheating nature - and yet, these technologies and medical advances are already at our fingertips.
All of this is to say that Bates and his team believe the opportunity in artificial intelligence (AI) and weight loss drugs (GLP-1s) is far from over - in fact, he believes it is really only just beginning.
When it comes to the latter, the only constraint to the growth of companies like Novo Nordisk (NASDAQ: NVO) and Eli Lilly (NYSE: LLY) is their ability to produce product fast enough. Meanwhile, Bates believes the next decade's market winners will be driven by who "wins" AI.
As part of Livewire's Undiscovered Funds Series, Bates shares some of the key lessons he's learnt since launching the strategy in late 2021. He explains why investors should prepare themselves for a very different market over the next decade, as well as how his team generates uncorrelated alpha.
Bates also shares some of the ways he's invested in AI and healthcare, and why he believes there is a major investment opportunity on offer as the world slowly becomes less global.
Fund Profile
- Name of the fund: T. Rowe Price Concentrated Global Equity Fund
- Asset Class: Global equities
- Year listed: 15 December 2021
- Description of strategy: An actively managed, style-balanced, high-conviction global equity fund that aims to deliver consistent positive excess returns over a full market cycle.
- Investment objective: Long-term capital appreciation
- Role the fund plays in a portfolio: Core
- Link to fund page: HERE
Why the next decade will look very different from the last
Bates started his career at T. Rowe Price in 2004, just a few short years before the Global Financial Crisis. What followed was a decade of zero interest rates, leading to reasonable nominal economic growth, but "pretty good" real growth.
"With low rates, the growth class of companies that could grow marginally faster than the nominal economy got extreme valuations, whether you were profitable or not," he recalls.
But COVID changed the playing field. And the response from governments – particularly in the US – to increase money supply by 30% had ramifications for nearly all asset classes.
"I think the next 10 years could be completely different from the last 10 years because of the changes that have happened in the global economy that link to inflation and interest rates," Bates says.
"In the next regime, instead of having inflation of 2% with nominal growth of 4%, which leads to real growth of 2%, I think you could have nominal growth that's still 4%, but inflation that's 3-4%, which leads to lower real growth but also higher interest rates."
This means that the cost of capital will be higher over the next decade. And the success of unprofitable companies along with wild valuations, are unlikely to continue.
Why AI is a game changer
While some argue that today's AI momentum is reminiscent of the Dot-com boom of the 2000s, Bates vehemently disagrees.
He notes that many of the businesses that exploded in the Dot-com boom and bust were either unprofitable or used leverage to help build their businesses. Today's AI winners, in comparison, are funding their investments with cash.
"Right now, all the AI tech funding is coming from companies like Microsoft (NASDAQ: MSFT), Amazon (NASDAQ: AMZN), Apple (NASDAQ: AAPL), Google (NASDAQ: GOOGL), and Meta (NASDAQ: FB). These are trillion-plus dollar companies that have hundreds of billions of cash on their balance sheets," Bates says.
"I think the table stakes for the next decade's winners are driven by who wins in AI. And so if you're in the Microsoft boardroom and you're talking about investment spending, you're not cutting AI because you're positioning the company for the next decade."
In addition, today's AI investments, unlike those of the dot-com boom (which focused on laying fibre), are continuously improving and focused on electricity utilisation and running at the fastest rate at the cheapest price, Bates says.
Bates is currently invested in Amazon (NASDAQ: AMZN), NVIDIA (NASDAQ: NVDA) and Microsoft (NASDAQ: MSFT).
The healthcare innovation helping the world "cheat nature"
Bates is bullish on weight loss drugs or GLP-1s, which are controlled by two companies - Novo Nordisk (NASDAQ: NVO) in Europe and Eli Lilly (NYSE: LLY) in the US.
"I own Eli Lilly over Novo because I think they have the best oral coming to market. They also have a more diversified pipeline with other things that are coming out," Bates says.
"Calculating the addressable market is very difficult, and the addressable market for these drugs is exploding. And so I think it's worth giving Eli Lilly and Novo time as stocks, even though right now they are optically expensive."
Aside from the obvious health benefits of losing weight, as well as helping ease pressure on healthcare systems, Bates believes the supply/demand dynamics for these drugs remain favourable.
"Really, the only constraint to growth is the capacity to produce the product," Bates says.
"I have a friend in America who has been using the product, and he had to stop taking it because he couldn't find it - meaning, pharmacies were out. So I don't know how prevalent the products are here, but they're coming and they are really miracle drugs."
In addition, Bates dubs healthcare company Danaher (NYSE: DHR) as a durable grower - a stock that doesn't have big drawdowns in EPS, and steady recurring revenues that enable businesses to gain operative leverage on costs - thus, helping these businesses grow profits faster than revenues.
"Danaher is ... a life sciences biopharmaceutical company that sells the equipment and the tools you need to make and test a lot of the new drugs that are being developed and used by the healthcare industry," he explains.
Earnings have come under pressure over the last two years as COVID-19 vaccine jabs dropped. But now, Bates believes that earnings have bottomed, and the company is about to enter a new phase of growth.
"Danaher can grow the top line 6-8% and EPS 10-15% annually over the next five years. And it's trading at a valuation that is not demanding at a mid-20s PE multiple," Bates says.
Re-shoring and what this means for US housing and infrastructure
Off the back of many of the supply chain issues during the COVID lockdowns, many companies are now "diversifying" their supply chains away from China.
"I think a lot of that means we need to bring things back to North America, whether it's Mexico or the United States," Bates says.
This will translate to more investment in infrastructure - which is good for steel, he adds, as well as more local freight and transport activity.
Bates owns Steel Dynamics (NYSE: STLD) and Canadian Pacific Kansas City (NYSE: CP) (which owns one of two railroads between Mexico and the US) here to benefit from these themes.
"I think we've also under-invested in US housing. US housing stock is incredibly old, so houses either need to be repaired or completely rebuilt," Bates says.
"When you look at demand for housing, it's exceptionally strong and prices are up because we don't have enough homes."
To benefit from increased spending in housing, Bates owns a company called Stanley Black & Decker (NYSE: SWK) - which makes power tools used in the construction of homes.
Learn more
Peter's portfolio is a high conviction global equity strategy that aims to provide long-term capital appreciation. The portfolio typically invests in mid to large cap companies in recognised markets throughout the world, including developing countries. For more information, please visit the T. Rowe Price website, or the fund profiles below.
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