Capex captains: How to invest as American productivity surges
Lisa Shalett, Chief Investment Officer, Morgan Stanley Wealth Management05/11/23
Summary: The coming years could bring stronger economic growth, greater business productivity, and a new set of stock market winners. How can investors position themselves now to benefit?
The pandemic delivered a once-in-a-generation shock to the economy. But as the world recovers, Morgan Stanley Wealth Management’s Chief Investment Officer Lisa Shalett believes a silver lining has emerged: That economic upheaval has also unleashed an entirely new combination of supply and demand trends that are igniting a powerful boom in capital investment by US businesses.
Shalett and her team of strategists believe this surge in new business spending could supercharge the economy, spurring stronger growth, greater productivity, and more widespread prosperity over the next several years. It will also likely produce a new set of stock-market winners—ones that look a lot different from the high-flying mega-cap tech stocks that dominated market indices during the last economic cycle.
Capital spending catalysts for a new supercycle
In this new environment, Morgan Stanley strategists believe companies must invest heavily in productivity-boosting capital assets, from enhanced computing infrastructure to new AI technology—creating opportunities for investors in the companies that are meeting these needs.
Over the next several years, Morgan Stanley strategists see these five transformational spending trends:
1. Digitalization of business models
The pandemic required companies of all shapes and sizes to digitize their business models for “contactless” customer experiences. Capex grew at an annual rate of over 15% in 2021, the fastest pace in about 40 years. While much of this spending began out of necessity early in the pandemic, more of it has shifted toward growth-supporting investments, as businesses continue to re-engineer their models for delivering products and services digitally.
2. Tighter labor markets
In the post-COVID-19 economy, fewer workers and upward pressure on wages have prompted employers to automate more jobs, helping bring down business costs and enabling some employees to shift skills to more productive roles.
3. Realignment of supply chains
The pandemic revealed vulnerabilities in globally integrated supply chains, leading companies to invest more in domestic production. This is being energized by the passage of spending bills like the:
- $1 trillion Bipartisan Infrastructure Bill;
- $50 billion CHIPS Act for US semiconductor investment; and
- 2022 Inflation Reduction Act, which included $369 billion in energy infrastructure spending.
4. The energy transition
New investments in traditional energy infrastructure—meant in large part to bolster Europe’s energy independence amid the war in Ukraine—are likely to eventually give way to accelerating decarbonization investments. That could bring increased capital spending on initiatives such as upgrading energy infrastructure and electrifying the US auto fleet.
5. A new “multipolar” geopolitical order
Rivalries are intensifying between nuclear superpowers, spurring public and private investments in areas such as defense, cybersecurity, and public health. In fact, US Department of Defense spending, as a share of annual Gross Domestic Product (GDP), is forecast to rise from 4.7% today to the roughly 6% level maintained in the early 2000s following the 9/11 attacks.
Sources of capital set to fuel the boom
Businesses may see a need to invest in new, productivity-enhancing capital projects, but they will need sufficient capital to enable those investments.
Here are four key sources of financial, human, and technological capital fueling the spending boom:
1. Historically healthy balance sheets
US households, businesses, and banks are enjoying their strongest financing position in decades. Balance sheets across the board remain excellent, having improved through more than a decade of reduced borrowing, stronger regulation, and low interest rates.
2. Shifting workforce demographics
The US workforce is transitioning from aging Baby Boomers to younger, tech-savvy generations. Growth of the prime working-age population (25-54) is poised to re-accelerate while the median working age is projected to decline over roughly the next decade. Shalett believes this generational turnover will help accelerate innovation and automation trends, resulting in healthier profits that can support increased capital investment.
3. A wave of scalable tech innovation
Innovation in the new economic cycle, is likely to feature technologies that are scalable, in areas more likely to boost business productivity and profits, such as data analytics and artificial intelligence, thus generating capital for reinvestment.
4. Monetary policy normalization
As the Federal Reserve normalizes policy to tame inflation, the era of negative real interest rates has come to an end. Higher rates could lead to a more efficient allocation of capital across the economy, which may starve unsustainable businesses of capital and steer resources toward growing businesses with the greatest potential to enhance productivity, and therefore, generate wealth.
Invest for a new era of growth
Morgan Stanley strategists believe it’s time for active stock-picking.
Here are five categories of stocks—dubbed “Capex Captains”—that Morgan Stanley strategists believe stand to benefit from a new US productivity boom:
These companies help businesses get more out of labor or upgrade the capabilities of an existing workforce and focus on things like:
- Automated surgeries
- Advanced medical testing
- Industrial automation
- Cyber-threat identification
These companies focus on both the energy transition, and using traditional energy sources to meet ongoing demand:
- Solar power
- Traditional oil and gas drilling
A new geopolitical order
As the world fragments into rival blocs, consider companies focused on:
- Cybersecurity, networks, and clouds
Finance and funding services
These companies help facilitate capital spending and include firms that:
- Underwrite debt
- Rate bonds or collect fees for the government
More specifically, Morgan Stanley strategists also favor the above companies if they have a market cap of over $5 billion and are established, have a projected topline revenue growth of at least 5% per year, and have a potential return-on-equity greater than the price-to-earnings ratio.
As always, when considering which of these investments may fit into your portfolio ahead of the upcoming productivity boom, be sure to keep in mind individual goals, timelines, and risk tolerance.
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