In the first quarter of 2023, the global economy continued to be characterized by the key challenges of 2022, including the ongoing COVID-19 pandemic, the war in Ukraine, rising inflation, and interest rate hikes. These challenges have had a significant impact on economic growth, trade, and investment, which has led to continued high market volatility.
For Green Alpha strategies, January 2023 provided double-digit performance gains as some of the above-listed concerns seemed to be easing, and then tougher markets in February and March as some issues seemed to reassert themselves, capped off by a positive rally at quarter-end as markets reverted to a more January-like dynamic. And yet, in context, inflation, interest rate concerns, and even geopolitical conflicts have historically been short-to-medium term sources of market volatility. As always, we endeavor to think about the longer term, and position our portfolios to preserve and grow our clients’ purchasing power over multi-cycle periods.
And yes, the global economy is also facing long-term challenges, such as the climate crisis, inequality, and technological change. These challenges will require governments, businesses, and individuals to work together to find solutions, and, in overcoming them, the world will make significant—it is not an exaggeration to say unprecedented—investments in the best of these solutions. The patient, forward-looking investor therefore stands to benefit. To illustrate, let’s look at a couple of sectors that saw big changes in Q1.
Carefully Navigating Tech’s Rapidly Evolving Landscape
The way we understand the tech economy is changing dramatically. Large language models (LLM) are exponentially improving, seemingly by the week, and traditional search and ad serving businesses are looking less like the indefinite cash cows that they did just last year. The codes for these models are improving so fast, in part, because the models themselves are becoming partially self-recursive in that they produce content not only in natural language but in code itself, meaning software engineers now have very capable “co-pilots” to help them develop the next LLM iteration faster than the last (this is part of why we don’t buy the general argument that productivity gains have flatlined). Ultimately, these models will be capable of generating ever-improving versions of themselves without direct human intervention and will be limited only by the capabilities of their underlying hardware.
Speaking of which, we can’t let this subject pass without acknowledging a key vulnerability to the global economy: utter dependence on the Taiwan Semiconductor Manufacturing Company (TSMC). According to recent reporting in Wired, TSMC is home to “the world’s biggest logic chip manufacturing capacity and produces, by one analysis, a staggering 92 percent of the world’s most avant-garde chips…Perhaps more to the point, TSMC makes a third of all the world’s silicon chips, notably the ones in iPhones and Macs. Every six months, just one of TSMC’s 13 foundries—the redoubtable Fab 18 in Tainan—carves and etches a quintillion transistors for Apple. In the form of these miniature masterpieces, which sit atop microchips, the semiconductor industry churns out more objects in a year than have ever been produced in all the other factories in all the other industries in the history of the world.” Unfortunately, this stunning and so far, singular capability resides on one island whose government believes it is a sovereign nation, but that is also claimed as territory by China.
Let’s face facts: the wonders we see from the LLMs don’t occur in isolation. OpenAI, Microsoft, Google, NVIDIA, Apple, and many more tech titans are utterly dependent on this one island with its N-of-One capabilities. The complex code that gives us Chat GPT and its kin have been made possible by the technological achievements at TSMC that brings forth the hardware capable of running these monster programs.
To run chat GPT and others, Microsoft Azure says they leverage up to “thousands of NVIDIA H100 GPUs interconnected by NVIDIA Quantum-2 InfiniBand networking,” all made at TSMC. We’re not big on fossil fuel analogies here at Green Alpha but imagine a world where Saudi Arabia has 92%of the world’s oil reserves and is at the same time struggling to maintain its independence from a determined world superpower. This overwhelming dependency on TSMC means the world’s economy is far more vulnerable to disruption than is generally assumed, and of course also means that TSMC is a significant holding in many Green Alpha investment strategies. Challenge and opportunity, hand-in-hand, as always.
Volatility is Unlocking Opportunities: Investing in REITs
Tech isn’t the only place where the challenge/opportunity dynamic exists. We can also see it in the more prosaic field of real estate. Real Estate Investment Trusts (REITs) have had a tough time in 2022 and Q1 2023 in the face of unprecedented Federal Reserve rate hikes and the ongoing phenomenon of work-from-home catalyzed by COVID-19. This pair of headwinds has caused even some of the highest quality REITs to be down more than 70% in the trailing year at the end of Q1 ’23, and, clearly with some justification. Looking more closely, though, we can see that not all REITs are, by any means, equal. While many mid-tier and lower quality office REITs are reporting occupancy levels not much better than 50%, the highest quality office REITs, with AAA space, great sustainability profiles, and in desirable markets, are more than 90% occupied with relatively strong lease pricing power.
Moreover, specialty REITs like those providing lab space for biotechnology are actively growing. The predilection of traders and algorithms to bid down the entire sector is basically a scorched earth approach that has resulted in some amazing value opportunities among the gems in the space. Benefitting from these low entry points requires patience, but is not, in our opinion, particularly risky for the long-term investor. It’s all about waiting for markets to appreciate that not all REITs are created equal, and the quality names have been oversold. Meanwhile, REITs compensate us for this patience with returns in the form of a dividend while we wait. This approach isn’t new in investing, it is a straightforward example of time-arbitrage; while we can’t be sure if it is or is not too soon to enter the highest-quality REIT space, we know for sure it is not too late. At some point, it will be.
Tech and REIT stocks are not often particularly correlated. As we’ve seen, they have very different dynamics, dependencies, and fundamentals; holding both is generally considered wise diversification. And yet, we have seen the global leaders in both industries lose share price value recently, even sometimes when their business results were good and improving.
The best thing an investor can do in volatile environments like these is maintain thesis conviction and convert the nearer term challenges into long-term opportunities via a carefully curated basket of securities. Near-term challenges create volatility, long-term challenges show us where to look for growth.
If you are a Green Alpha client, contact email@example.com to inquire whether your account(s) holds any of the securities listed in this macroeconomic commentary. At the time this commentary was written, Green Alpha held shares in Taiwan Semiconductor Manufacturing Co (TSMC), NVIDIA (NVDA), and Apple (AAPL) in some client accounts. This holding does not represent all of the securities purchased, sold, or recommended for advisory clients. You may request a list of all recommendations made by Green Alpha in the past year by emailing a request to any of us. It should not be assumed that the recommendations made in the past or future were or will be profitable or equal the performance of the security cited as an example in this recording. To inquire whether a specific Green Alpha portfolio(s) holds stock in any particular company, please email us. Please see additional important disclosures here: https://greenalphaadvisors.com/about-us/legal-disclaimers/. No Green Alpha client accounts held shares in Microsoft (MSFT) or Google (GOOG) at the time of authorship.
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