Getting through market volatility via thematic investing

Recently concerns over high inflation, rising interest rates, and geopolitical crisis have undoubtedly put pressure on stock market’s performance. However from the perspective of “thematic investing,” we can continue to identify long-term growth opportunities driven by certain structural changes and themes in the current environment.

Continued disruption of global supply chains has further pushed up inflation and weakened corporate earnings. Under this backdrop, production automation will gain traction due to the ability to reduce the reliance on human labour and labour costs, as well as to control product quality. This will create investment opportunities that smart manufacturing will benefit from. Besides automation, smart manufacturing also covers technologies such as sensor, testing, information, internet, and artificial intelligence. Companies focusing on the relevant technologies will receive more attention as there is still significant room for cost reduction coupled with rapid technological advancements.

Besides inflation, another key concern in the market has been the ongoing Russia-Ukraine conflict, which has triggered soaring energy prices. Russia is the European Union’s largest supplier of gas, oil, and coal. The European Commission aims to reduce its reliance on Russian gas by two thirds by the end of 2022, and cease its purchase of fossil fuels from Russia before 2030.

In this context, energy transition as a theme has received heightened worldwide attention. Its urgency is further amplified by the Russia-Ukraine crisis, with identified measures including accelerating renewable energy development, promoting electrical-driven heat pumps, and setting higher short-term green hydrogen targets.

Although wind and solar powered projects face rising costs with inflation, the increase in costs is still insignificant compared with the rising electricity costs generated by traditional energy sources such as coal and gas, and technological advancement is one of the important reasons for keeping the cost under control.

We have seen increasing new applications that improve efficiency, which help to offset the rising costs of land, construction, engineering and equipment.

In addition, as the Fed starts the rate hike cycle, some growth-oriented stocks may face downward pressure in the short term. In this environment, some themes can be seen as more value-focus and may offer better protection, one of which is the sustainable food and water theme.

Year to date, amid rate hikes and geopolitical tensions, some sustainable food companies have recorded impressive gains. For example, some Canada-based fertiliser producers have benefited from rising fertiliser prices, due to supply chain disruptions caused by the Russia-Ukraine conflict.

This theme also offers large potential for growth over the long term. Expansion in global population will create increased pressure on food supply and water resources, which in turn will also create soaring demand for investments in agricultural and water supply systems. Sustainable food and beverage producers are expected to be the beneficiaries, especially for the dominant companies that can expand profits through price increases.

Overall, under the current environment, we believe that a diversified and flexible investment strategy for both asset allocation and thematic investing is well positioned to provide investors with exposures to growth opportunities while managing downside risk.