Megatrends: Three investing themes for the next bull market

Investors who enjoyed the rallies of the pandemic bull market saw many of their gains disappear in 2022. But there’s a bright side: Bear markets—when a broad market index falls 20% or more—often create some opportunities to invest at discounted prices.

What’s more, while rising share prices can make a variety of stocks look attractive, market downturns offer a glimpse of the stocks showing what’s known as “relative strength”—those holding up best on the way down and leading on the way back up.

Morgan Stanley Wealth Management’s thematic investing team believes that investing in companies benefiting from long-term growth trends, at historically attractive valuations, can be a recipe for success. Below, are three investment themes to consider in preparation for the next bull market.

Millennials are now the largest living US adult generation, with Gen Z the second-largest. As these two generations enter their peak years for earning a salary and building a household, investors should consider their spending needs and preferences.

As the incomes, spending power, and spending behaviors—like preferences for online shopping—of these generational cohorts grow, e-commerce giants and brick-and-mortar retailers with a strong digital presence are poised to benefit alongside supporting businesses like logistics providers and social media platforms. Morgan Stanley Research has found that consumers ages 35-44 and 45-54 tend to spend the most on apparel, and in the years ahead, strategists think apparel brands popular with Millennials stand to benefit from this propensity.

Separately, demand for homes among Millennials and Gen Z is likely to create a long-term tailwind for the US housing market. While household formation rates, or household growth, fell to multi-decade lows after the 2008 financial crisis, the trend started turning up in 2015 and is likely to stay on that path as Millennials continue getting married and starting families in the coming years, followed by Gen Z in the next decade. This trend could drive robust homebuilding activity, as builders play catch-up after a period of tight supply.

For some investors, it could be time to consider portfolio exposure to the trend in housing: As of early April, the S&P Homebuilders Select Industry Total Return Index, for example, was recently trading at a 12.4 price-earning (P/E) ratio, below both its pre-COVID-19 and five-year averages. These stocks have also been “leading on the way back up,” with gains of 17.2% since the market’s October 2022 low versus about 15% for the S&P 500 Index.¹

Semiconductors are the foundation on which numerous other technologies are built. There is massive demand today for the commoditized chips that help run everyday technology like phones, cars, and smart appliances. Looking ahead, the rapid rise of data-intensive applications, such as new forms of artificial intelligence (AI), means there could be significant future demand for even more advanced microprocessors.

US-based public policy also supports increased demand for semiconductors. To prevent the kinds of cascading global chip shortages seen early in the pandemic, and to shore up domestic production amid mounting geopolitical concerns, policymakers and companies alike are now pushing to “re-shore,” or bring back, semiconductor manufacturing to the US. The America COMPETES Act, for example, carved out $52 billion for domestic semiconductor manufacturing and research.²

Likely beneficiaries include US semiconductor manufacturers, companies that contribute to the US semiconductor supply chain and those that will support the infrastructure required to build out the domestic semiconductor industry, such as freight and trucking providers and industrial property companies.

US semiconductor stocks, as measured by the Philadelphia Semiconductor Index, recently traded at 21.4 times current earnings as of early April, making them somewhat pricey relative to their own recent history. However, they have shown remarkable relative strength, gaining 40.4% since the stock market’s October 2022 trough.³

While the global population is projected to grow roughly 20% to top 10 billion people in the next 25 years⁴, climate change could pose a significant negative impact on the production of staples such as wheat, rice, maize, and soybeans.

Innovative solutions for increasing food production and enhancing access to clean water can help meet sustenance goals in a sustainable way, and the companies working toward those innovative solutions are likely to benefit.

Looking closer, the need for clean drinking water is already critical: By 2030, the gap between global demand and supply for freshwater is expected to reach 40%. To help close the gap, Morgan Stanley researchers forecast $1.4 trillion will be invested over the next several years to expand and improve global water infrastructure to better treat, transport and conserve water.

For example, smart metering systems can help utilities improve water billing so that water is both conserved and priced accurately. Other capital projects, meanwhile, are working to help increase the freshwater supply. In 2020, for instance, desalination—the process of removing salt and other particles from seawater—accounted for only about 1% of global freshwater demand. Meanwhile, as governments and companies seek to increase the freshwater supply, the desalination market is projected to grow around 9% annually through 2025.⁵

Stocks in the S&P Global Water Index, with a 29.8 P/E ratio, appear richly valued relative to their own recent history. However, they have shown impressive relative strength as of early April, having gained 22.1% since October 2022.⁶ Long term, constraints on water supply are likely to drive significant new investment in water infrastructure and agriculture technologies, and add potential upside for these stocks.

As always, when considering which of these investments may fit into your portfolio, be sure to keep in mind individual goals, timelines, and risk tolerance.  Also, keep in mind that investing involves risks and it’s possible to lose money.

1. S&P Dow Jones Indices, "S&P Homebuilders Select Industry Index"
2. WhiteHouse.gov, "FACT SHEET: CHIPS and Science Act Will Lower Costs, Create Jobs, Strengthen Supply Chains, and Counter China"
3. Nasdaq, "History for SOX"
4. The World Bank, "Agriculture and Food"
5. GlobeNewswire.com, "Water Desalination Market Size to hit USD 29.1 billion 2030"
6. S&P Dow Jones Indices, "S&P Global Water Index"

The source of this article, “3 Investment Themes For the Next Bull Market,” was originally published on April 20, 2023. Index returns are shown for illustrative purposes only and do not reflect transaction costs and taxes, which would lower returns. An investment cannot be made directly in an index. Past performance does not guarantee future results.