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Investing in change: 5 sectors to watch

Broad shifts in the economy, from inflation to global unrest, are creating opportunities that investors may want to consider now

July 14, 2022

“The planet will need to produce more food in the next four decades than in the past 8,000 years.”1

Joseph P. Quinlan, head of CIO Market Strategy, Chief Investment Office, Merrill and Bank of America Private Bank

INVESTORS ARE WITNESSING “a great rotation,” says Chris Hyzy, Chief Investment Officer, Merrill and Bank of America Private Bank. “Some of the companies that experienced extraordinary returns in recent years are finding themselves most vulnerable to higher inflation and rising interest rates,” he notes. Take, for example, the technology sector, which has struggled in 2022 after dominating equity markets for more than a decade. At the same time, other sectors, better positioned for potential growth amid today’s inflation, rising global tensions and the transition to renewable energies, are emerging as promising areas for investors to consider, he adds.

Specifically, “these five areas — fuels, aerospace and defense, agriculture, nuclear, and gold/metals/minerals — are poised to benefit in a new world of geopolitical risks with an intense focus on resources and hard assets,” says Lauren J. Sanfilippo, senior investment strategy analyst with the Chief Investment Office (CIO), Merrill and Bank of America Private Bank. “You could call them FAANG 2.0,” she adds. They represent a twist on the so-called “FAANG” stocks, a popular acronym coined back in 2013 for five of the world’s largest tech companies. “But instead of specific stocks, we’re focusing on several broader sectors.”

Sanfilippo and Joseph P. Quinlan, head of CIO Market Strategy, highlight these sectors in a Capital Market Outlook report, “Our Portfolio Tilt: Think FAANG 2.0.” “We believe they may offer future value as the economic rotation continues,” says Quinlan.

Why they’re poised for potential growth

F – Fuels. The energy sector has declined as a market force in recent decades, representing just 4.7% of the S&P 500’s total market capitalization today, compared with 13.4% in 1990, Sanfilippo notes. Yet that very decline leaves the sector primed for growth at a time when the war in Ukraine has redrawn supply chains and countries emerging from the global pandemic need energy to power their economies. “A combination of geopolitical tensions, constrained supplies, strong demand and underinvestment will likely keep energy prices elevated over the medium term,” Sanfilippo says.

A – Aerospace and defense. With a war raging not far from their borders, European countries are re-arming. “Germany, for example, has pledged twice its annual defense budget,” Sanfilippo notes. “At a minimum, the North Atlantic Treaty Organization requires each member to contribute more than 2% of gross domestic product to defense by 2024.” Asian countries, too, are stepping up defense spending, and the upswing in spending includes not just weaponry but cybersecurity. Defense stocks have outperformed the broader market in 2022, and heightened spending is likely to continue, she says.

A – Agriculture. Even without today’s turbulent forces, agriculture would be a key sector to watch. “The planet will need to produce more food in the next four decades than in the past 8,000 years,”1 says Quinlan. Moreover, agriculture as an investment sector may offer some protection from inflation. “Equipment shortages, higher input costs, climate challenges and burgeoning demand from the emerging-markets middle class all suggest more upside earnings potential for the global agricultural complex,” he adds.

“A typical electric vehicle requires six times the mineral inputs of a conventional car, according to the International Energy Agency.”

Lauren J. Sanfilippo, senior investment strategy analyst, Chief Investment Office, Merrill and Bank of America Private Bank

N – Nuclear and renewable energy. Use of renewable energies such as solar and wind rose during the depths of the pandemic in 2020, even as demand for other energy sources declined. “Long-term contracts, ongoing installation of plants and priority access to the grid are among the reasons renewables should continue to grow,”2 Quinlan notes, adding that “in our opinion, nuclear energy will play a significant role in a clean-energy future. Nuclear has the highest capacity factor of any energy source, producing reliable, carbon-free power more than 92% of the time. That’s twice as reliable as coal or natural-gas plants and almost three times more than wind and solar plants.”3 For more insights on the global green energy market, read “The Geopolitics of Clean Energy Commodities” from the CIO.

G – Gold and minerals. This sector is increasingly attractive for a couple of reasons, Sanfilippo notes. First, gold is widely seen as a “safe haven” from inflation and geopolitical unrest. Second, minerals are essential to the transition to cleaner energy, particularly the batteries that power electric vehicles (EVs). “A typical EV requires six times the mineral inputs of a conventional car, according to the International Energy Agency,” Sanfilippo says. The need for lithium, for example, could increase by 40 times over current demand.4 Real assets, she adds, are in a longer term bull cycle and will likely go through periods of high volatility, much as we’re seeing now.

What investors can consider

To capture the potential of some of these areas, investors might consider stocks related to defense and cybersecurity, as well as traditional and renewable energies and food production, Quinlan notes. Commodities may be worth considering as well, since they traditionally offer protection from inflation, and because they will be central to meeting demand for everything from food to minerals used in EV batteries.

Yet while investors should be aware of and plan for these economic shifts, the emergence of potential FAANG 2.0 opportunities doesn’t mean abandoning other investments in your portfolio, including the tech sector. Any new investments should be made within the context of your long-term financial goals, Hyzy cautions. “If a strategic asset allocation plan is the heart of investing, diversification is the circulatory system, and long-term and goals-based thinking is the brain.” Keeping those qualities in mind may be the best way to pursue opportunities without making precipitous decisions.

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