Globally, inflation has been a main topic of conversation among investors this year, as well as the Fed’s ability to handle it. In the last few commentaries, we shared our views on the ongoing inflationary pressures and why we think the target of 2% is hardly achievable in the near future. Aside from an unprecedented monetary and fiscal stimulus, spiking energy prices and supply chain disruptions caused by Covid and the war in Ukraine, the main driving forces of current inflation include labour shortages and rising wages.

Indeed, it’s what we are currently experiencing and what some experts in the U.S. are calling the tightest labour market in 70 years. During a panel in Washington hosted by the International Monetary Fund, Fed Chair Jerome Powell described the current state of the U.S. labour market as unsustainably hot.[1] According to the U.S. Labor Department’s Job Openings and Labor Turnover Survey, in March 2022, the number of job openings increased to 11.5 million, from 11.3 million in February. Moreover, there were almost two vacancies for every unemployed person, pointing to an intensifying tightness and further wage pressure.[2] These trends are supported anecdotally while businesses from different sectors report difficulties hiring talent and surging labour costs. When we talk to companies in our emerging markets (EM) universe, we get similar feedback with a slightly varying magnitude in different regions.

As much as one wants to credit purely Covid, the fundamental reasons underlying labour tightness started to surface before the pandemic. Demographics, immigration policy and de-globalization trends have sowed the seeds of the current environment. Covid and the fiscal response to it only added fuel to the fire. The working-age population has slowed in many Organisation for Economic Co-operation and Development (OECD) countries since early 2000.[3] Short-sighted immigration policies in some countries have contributed to that slowdown. A tremendous cost advantage that China enjoyed for years winded down by 2015-2016 due to wage growth and demographics. During the Covid pandemic, many governments found themselves navigating through unchartered territory. Some of those responded with massive fiscal stimulus, which created an unprecedented demand for goods and services, and eventually labour.

There is also a social component to the set-up as the relationship between capital and labour undergoes a fundamental transformation. For example, in the U.S., the population has higher savings, and as a result, this means an improved bargaining power over employers. In many instances, employees can dictate working conditions by pushing for more remote work. Low minimum wages became a major political issue a long time ago. Every year, a larger percentage of people of different ages are reported to be suffering from various mental health issues. Covid was an accelerator of many burnouts that happened in the last two years. And it’s far from being an issue only in developed markets.

For instance, the majority of office workers in India are reportedly suffering from enormous pressure because their colleagues are quitting.[4] The pandemic has radically changed how people work and what the job means to them. As a result, it has contributed to “the Great Resignation”. These factors are reshaping how managers think about their employees, as well as their mental health and wellness. CEOs acknowledge that human capital is the most important asset in any business. Engaging in the current wars for talent, employers have no choice but to pay up. Shorter work weeks could become more common as companies across the world are experimenting with a four-day work week. Additionally, a strong corporate culture and Diversity and Inclusion (D&I) policy have become an important differentiator of successful businesses.

We believe the current labour market issues will persist and become the major drivers of inflation. So, how do we position our EM portfolio from this perspective?

• We prioritize companies that exercise a superior level of pricing power, have a strong culture and a track record of attracting and retaining talent, have a solid D&I policy, and are relatively less labour intensive. An analysis of social aspects is an integral part of the comprehensive ESG due diligence that we make on every candidate for inclusion in our portfolio.
  
• We prefer companies with strong balance sheets and industry-leading margin profiles. As labour shortages limit capacity to grow, companies have to gain efficiencies. An economy with excessive demands creates enough incentives for businesses to invest in productivity improvement. Although we acknowledge a time lag between investments made and productivity improvements, we believe that our holdings should come out as winners in the medium to long term.
  
• We look for businesses that can capitalize on this environment, especially those in the automation space.

E Ink Holdings Inc. (8069 TT)

E Ink, based in Taiwan, is the global leader in Electronic Paper Display (EPD) technology. Also known as ePaper, it allows devices to mimic the appearance of ordinary ink on paper and is widely adopted in several end applications, including Electronic Shelf Labels (ESL), eReaders and various IoT solutions.

Unlike LCD and OLED, EPD does not require power to hold an image and consumes energy only when the content is being changed, has no backlight, uses ambient light from the environment and is easy on the eyes. It’s also thinner, flexible and rugged. ESL attaches to the shelves with EPD that show price, sales promotions, and other product information and replaces conventional paper price tags.

Due to wireless data transmission capability, the solution allows for real-time information updates. ESL not only reduces the labour cost associated with a manual replacement of price tags but also minimizes the likelihood of pricing errors and enables stores to quickly improve their efficiency in a highly competitive market. Implementation of in-store technologies and the increasing adoption of smart shelves are driving the continued growth in demand for ESL. The current penetration rate in retail markets is only 4-5%, suggesting plenty of room to grow for E Ink as it commands virtually 100% of the market share in the ESL upstream material supply. The global ESL market is expected to grow at a CAGR of over 18% during 2022-2032 and will exceed US $5 billion by 2032.[5] We like E Ink’s monopoly-like position in a niche market, with strong IP protection, vertical integration, solid R&D capabilities, and placing it in a unique stance to benefit from the rapid industry growth driven by increasing the adoption of ESL, new colour ePaper products, and wider IoT penetration.

Estun Automation Co. Ltd. (002747 CH)

Estun is one of the leading Chinese industrial robot manufacturers, with strong product competitiveness and diversified end-market exposure, including lithium batteries, solar, construction, automotive and consumer electronics. We believe the company is set to benefit from a rising demand for industrial robots in China, given labour tightness and surging wages in that country. After peaking in 2015, the labour force in China has since been on a consistent decline,[6] likely falling victim to the former one-child policy. Moreover, we believe that labour shortages in the manufacturing industry will get only worse due to competition from the new economy companies that lure talent with higher wages and other benefits. Although fighting input cost inflation and supply chain issues in the near term, we believe Estun will be among the winners in the factory automation space, enjoying favourable demographic trends and government policy tailwinds.

Guangzhou KDT Machinery Co. Ltd. (002833 CH)

Based in China, KDT Machinery is a global leader in the production of automated equipment for panel-type furniture, with significant market share growth potential. We like its solid technological know-how, strong cost competitiveness, scale and manufacturing capabilities. As furniture producers globally chase efficiency improvements, automation solutions are expected to enjoy a robust demand in the long term. KDT Machinery not only facilitates the shift from labour to automation in the furniture manufacturing industry, which has been historically high labour intensive, but also contributes to forest protection and CO₂ emissions reduction on the back of panel-type furniture replacing solid wood.

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[1] https://www.reuters.com/business/finance/feds-powell-half-point-rate-increase-table-may-meeting-2022-04-21/

[2] https://www.bloomberg.com/news/articles/2022-05-03/u-s-job-openings-rose-unexpectedly-to-record-11-5-million

[3] https://data.oecd.org/pop/working-age-population.htm

[4] https://www.dqindia.com/labor-shortage-in-india-is-real-heres-why-people-are-quitting-their-jobs/#:~:text=According%20to%20a%20new%20study,the%20highest%20in%20any%20region

[5] https://www.prnewswire.com/news-releases/electronic-shelf-label-market-to-reach-usd-5-2-bn-by-2032–latest-factmr-study-301490430.html

[6] https://www.china-briefing.com/news/china-labor-market-hiring-costs-job-preferences-talent-acquisition/#:~:text=Distribution%20of%20local%20workforce,quarters%20of%20the%20US%20population

When most countries are wrestling with rising inflation, Japan is the outlier.

In March 2022, Japan’s consumer price index (CPI) growth was only 1.2% year-over-year, versus 8.5% in the United States (U.S.). Japan’s CPI has risen only 5.5% over the past 20 years, compared to 60% in the U.S.

Inflation rate in Japan (%)[1]

In theory, it is due to a long-term demand-deficient feedback loop.

1. Expectations built up through decades of low inflation or deflation
2. Weak consumer spending caused by aging population
3. Firms’ caution on wage and price increases
4. Stagnant wage growth constrains consumer spending

In reality, for many years, the story goes like this: Anyone under 40 years old in Japan has never really experienced rising inflation. If prices go up, consumers will spend less. Therefore, firms are reluctant to increase prices. To keep costs in control, firms keep wages stable, which does not stimulate consumer demand.

However, since September 2021, the inflation rate has been increasing, from -0.4% in August, 0.2% in September, to 1.2% in March, all due to high commodity prices. On April 26, the Bank of Japan (BOJ) reiterated its commitment to low-interest rates despite rising inflation, saying: “It is most important to support economic recovery by patiently continuing monetary easing.”

At Global Alpha, we are supportive of the BOJ’s policy. Rising inflation in Japan this year is inevitable but desirable. Looked at another way, the present inflationary trend could be an opportunity for Japan to finally escape from deflation.

All our Japanese holdings said they had raised their prices in the past year. According to the Teikoku Databank Ltd survey of 1,855 companies conducted in early April[2], 43.2% of the firms said they raised prices in April or plan to do so by the end of March 2023. When combined with the firms that have already raised prices between October and March, the percentage reaches 64.7% of the total.

The key for Japan to fight deflation is wage increases. According to data by the Organization for Economic Co-operation and Development (OECD), the average annual wage in Japan increased until 1997 to $38,395 and then flattened out. In 2020, the average Japanese workers made $38,515.

In November 2021, Japan’s new Prime Minister, Fumio Kishida, made it clear that raising wages is one of the top priorities for his economic agenda. He urged firms whose earnings have recovered to pre-pandemic levels to increase wages by 3% or more at their labour talks this spring. Prime Minister Kishida also pledged to raise the incomes of welfare workers, such as childcare workers, nurses and caregivers, by 3%, continuously.

Of course, a policy does not lead to easy solutions, considering Japan’s rigid employment culture, the large presence of part-time and contract workers, and a weak yen. The progress is yet to be seen.

Japan has been a very important market for our investments. Despite low inflation pressure and limited geopolitical risk, Japanese stocks are currently trading at an attractive valuation compared to other markets.

Forward Price/Earnings

This year, JPY against USD has weakened by over 10%. The 130 milestone was the highest in two decades. We believe the rate should revert to 100 – 110 in the coming years. Meanwhile, a weak yen benefits exporters and encourages inbound travel. As Japan reopens, we foresee “revenge spending” from in-bound travellers. In 2019, almost 32 million foreign tourists spent 4.8 trillion yen.

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[1] Japan Inflation Rate – April 2022 Data – 1958-2021 Historical – May Forecast (tradingeconomics.com)

[2] Get ready to pay more: Over 40% of Japanese firms to raise prices within a year: survey – Japan Today

Higher input prices are having an adverse impact on household sentiment. European sentiment indicator turned negative in March, while UK consumer confidence fell close to an all-time low in April. Surprisingly, U.S. consumer sentiment unexpectedly rose to a three-month high in early April. Although consumers have accumulated savings through the pandemic, we believe that consumers may prioritize leisure spending over discretionary goods in the months ahead.[1]

Not all product categories performed equally in this context of high inflation. Companies that emerged as winners during the height of the pandemic have fallen back since. The streaming giant Netflix reported a loss of 200,000 members in the first quarter, with a forecasted drop of 2 million this quarter. The company blames the password-sharing business for the loss in subscribers. Netflix, which is already the most expensive streaming platform, has recently increased its pricing in some Latin American countries for sharing accounts between households.[2] With an increased offering of streaming platforms at the same time as consumers are shifting their dollar spending elsewhere, it will be interesting to see how loyal subscribers are.

There are still areas in the economy where demand for goods remains robust. Companies associated with recreational and outdoor activities seem to report strong trading updates. Companies like POOLCORP, Tractor Supply Co and Gardena have benefited during their latest publications compared to last year.[3],[4] In general, we feel like the big ticket items could experience a growing trend going forward. On the other hand, food, health, and some services linked to the post-pandemic reopening might still experience robust growth.

There are some interesting data points that suggest strong spending patterns in service-related categories:

• OpenTable data suggests that consumer demand for restaurants continued its upward trajectory as of April 19, 2022. The Dining Out index, which tracks restaurant reservation data for approximately 20,000 restaurants across seven countries, shows that so far in 2022, the number of seated diners increased by 24% in the UK, 17% in the U.S. and 45% in Germany. Historically, higher gas prices have negatively impacted restaurant consumption as consumers change their eating habits, but this time around, consumers seems to be holding on to that spending category.

• Airlines and hotels have also seen an important surge in demand. Delta Air Lines returned to profitability during March, thanks to a passenger revenue that is back to 75% of pre-Covid levels. According to a survey conducted by the World Travel & Tourism Council, travellers are currently planning on spending more on travel leisure than they have in the past five years. [5],[6]

As the economy and consumer behaviours turn more towards services over goods, the exposure to small caps could provide investors with some upside.[7] Small caps, which tend to be more domestic, seem to have a stronger representation of services as opposed to goods. According to the Bank of America, the S&P 500 index derives around half of its earnings from spending on goods, whereas the Russell 2000 index generates only a quarter of its earnings from spending on goods.

Small-cap indices have a better representation of leisure services when comparing it with the S&P500. The weight in the leisure industry services is approximately 1% for the S&P 500 index, as opposed to 3% for the Russell 2000 index.

Some companies we own should benefit from that spending pattern:

Autogrill is the global leader by revenue in the F&B concessions market in airports, motorways, and railway stations. Autogrill and its subsidiary, HMSHost, manage a portfolio of about 300 owned and licensed brands in over 30 countries, including proprietary brands (Spizzico, Puro Gusto, etc.) and third-party franchises with a particular emphasis on global brands (Burger King, Starbucks, etc.).

Meliá is one of the leading European hotel groups; it owns and manages more than 326 hotels and resorts in 33 countries, mainly in America and Europe. Now that the majority of travel restrictions have been lifted, Meliá is seeing an uptick in demand for its leisure hotels. The Easter holiday was strong, and booking trends for the upcoming summer look firm. Although wider concerns around consumer softness are unlikely to completely fade at this stage, investors are likely to focus on mix shifts and changes in demand across product categories. Companies that have continued to invest and managed to enlarge their market positioning should be in a better position to offset the broader market slowdown.

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[1] https://www.reuters.com/world/uk/uk-consumer-morale-plunges-near-all-time-low-april-gfk-2022-04-21/

[2] https://www.google.com/amp/s/www.cnbc.com/amp/2022/04/19/netflix-nflx-earnings-q1-2022.html

[3] https://finance.yahoo.com/news/zacks-analyst-blog-highlights-j-113011500.html

[4] https://www.google.com/amp/s/www.marketscreener.com/amp/quote/stock/HUSQVARNA-AB-PUBL-6498674/news/Husqvarna-Group-INTERIM-REPORT-JANUARY-MARCH-2022-Strong-demand-but-sales-affected-by-supply-ch-40125061/

[5] https://www.hospitalitynet.org/news/4110148.html

[6] https://www.barrons.com/articles/-travel-booming-again-hotels-airlines-51649890847

[7] https://financialpost.com/pmn/business-pmn/two-speed-euro-zone-economy-as-services-shine-factories-struggle-pmi

In 2013, the investment world was introduced to the term FANG by CNBC’s Mad Money host. Of course, we all know the tech giants represented by this acronym: Facebook, Amazon, Netflix, and Google.

Almost a decade later, the term FANG is back in the news. But this time around, the almighty tech companies have been dethroned by four of the most traditional, old school industries in the world. We’re talking about Fuel, Agriculture, Natural Resources, and Gold.

Historically every time this group took the lead in the last century (1939, 1972, 2000), we have seen inflation skyrocket for years to come, leading to political unrest around the world and major corrections in financial markets. We are set to see history repeat itself once again.

In today’s weekly we focus on agriculture, which is heading into a super cycle.

Time and time again, the agriculture industry has weathered economic uncertainty. No wonder it’s one of the oldest, most reliable asset classes. It is also one of the best inflation hedges as food prices are closely linked to inflationary trends.

How big is the agriculture industry?

American farms alone contributed $124 billion in United States (U.S.) gross domestic product in 2020. Farmland is still an unknown asset for many, and the largest farmland owner in the U.S. is not even a farmer. It’s Bill Gates, who currently owns 242,000 acres of land. Isn’t it ironic that one of the world’s biggest tech company founders sees more value in dirt? Clearly this is an indicator that land is about to get a lot more valuable.

Globally, agriculture is a large and growing industry worth over $10 trillion in 2020. It is expected to increase to $12 trillion in the coming years.

The drivers for this growth are simple:

• an ever-expanding global population,
• urbanization, and
• transition towards regenerative sustainable farming.

Russia/Ukraine impact on global Agriculture

The war in Ukraine has delivered a shock to global energy markets. Now the planet is facing a deeper crisis: a shortage of food. Since the invasion last month, wheat, barley and fertilizers have seen prices increase over 20 percent.

With a cultivation of about 32 million hectares of land, Russia and Ukraine supply a quarter of the world’s wheat and half of its sunflower products.

Ukraine is known as the “breadbasket of Europe” thanks to its perfect climate and ideal geology for agriculture. Over 70 percent of the landscape consists of fertile plains with deep rich soils. Ukraine has warm summers, cold winters, and plenty of rain, providing excellent conditions for plant growth, and disease and pest prevention.

An unstable Ukraine = Another Arab Spring?

Ukraine is the world’s fifth-largest producer of corn (maize), and the eighth-largest producer of wheat. Approximately 12% of Ukrainian corn is sold to Egypt. It accounts for 80% of Lebanon’s and 25% of Egypt’s wheat imports, and is a leading supplier for countries like Somalia, Syria and Libya. It should come as no surprise that the current conflict will push up commodity prices even further.

Most Middle East countries use the Black Sea for trade. However, due to the war in Ukraine agriculture supplies (and all other products) have to travel a different route – which given current fuel prices will only increase the freight cost. Supply shortage and an expensive freight will further compound price inflation in the Middle East.

When we look back to 2009/10, food prices were one of the main triggers of the Arab Spring uprisings in the Middle East. Back then, social unrest started in Tunisia, which saw its authoritarian government fall in less than two weeks. Then the crisis hit countries like Egypt, Yemen, Libya, Syria, and Saudi Arabia. In the chart below we can see that food prices have already exceeded levels last seen in 2011. We could be looking at another round of instability in the middle east.

Portfolio impact

Our portfolio is extremely well positioned to benefit from both high inflation and opportunities in the fast growing agriculture industry. 

When it comes to inflation, smaller companies generally outperform their larger peers. From January 1979 to July 1983, the Russell 2000 Index outperformed the S&P 500 Index by 81% (see chart below). During this time, inflation rose to as high as 13% and the economy suffered a double-dip recession in 1980 and 1981-82, before staging an extremely strong recovery in 1983 with growth rates as high as 8.5%.

In the agriculture industry, we own the following names which we believe will grow faster than the industry and deliver superior earnings.

Limoneira (LMNR)

Founded in Ventura County, California in 1893, Limoneira is one of the largest growers and marketers of lemons in the U.S. It is also the largest grower of avocados in the U.S. Besides the steadily growing agribusiness, Limoneira’s strategy is to unlock the value of over 10,000 acres of agricultural land, real estate development opportunities and water rights mainly in Southern California.

Titan Machinery (TITN)

Titan Machinery is the largest Case New Holland dealer in the U.S. with 75 stores, mainly in the Midwest, and some in Eastern Europe. According to the U.S. Department of Agriculture (USDA), net farm income is 26% higher than the 10-year average. Farm income is forecasted to reach its highest level since 2013. This bodes well for equipment upgrade cycles in general. Also, drought in South America is causing a shortage of soybeans and corn. U.S. farmers are now focusing on these crops and should see higher incomes well into 2023.

Lindsay Corporation (LNN)

Based in Omaha, from its humble beginnings as a small operation in rural American Midwest, Lindsay has become a global leader in irrigation and infrastructure. Their irrigation and water management solution should see strong take rates by farmers.

Farmland Partners (FPI)

Farmland Partners is a real estate company that owns approximately 160,000 acres of high-quality farmland in 17 states. Their land is being farmed by over 100 tenants who grow 26 major commercial crops. Farmland should benefit not only from increased rent, but also some profit share agreements on certain properties.

Bucher Industries AG (BUCN) 

Bucher is an internationally operating Swiss engineering group. Bucher’s divisions are focused on specialized agricultural machinery, municipal vehicles, hydraulic components, manufacturing equipment for the glass container industry, as well as equipment for processing of beverages.

Sakata Seed (1377)

Based in Yokohama, Sakata is a leading seed company in Japan. Sakata ranks in the top three for vegetable and flower seeds in Japan, and number six in the world. They have a product lineup of 1700 flower varieties of 100 species and 400 vegetable varieties (mainly broccoli, cabbage, carrot).

Meanwhile, Global Alpha is back on the road again. In less than a month, we will be visiting holdings like Limoneira and Farmland Partners to evaluate their operations and performance. We have also begun visiting trade shows and have recently returned from the 43rd Annual Institutional Investors Raymond James conference in Orlando. We look forward to keeping you posted on new trends, opportunities, and ways we are generating alpha for our clients.

On July 8, 2021, our commentary addressed inflation and the debate about whether it was transitory or secular. At the time, the consensus of Central Bankers and most economists, was that it was transitory.

In this week’s commentary, we predict that a 2% inflation goal in the U.S. is not achievable for many years to come. The new long-term inflation rate will be more around 3%, and possibly higher. How central banks will adjust their policy to this new reality remains to be seen.

Inflation targeting: a history

Since 1996, the United States (U.S.) Fed has used monetary policy with the aim of keeping inflation at 2%. In 2012, Ben Bernanke, then chair of the Fed, made it explicit. Japan, Sweden, the European Central Bank (ECB), Canada, the Bank of England and many others have all since been using this 2% target. 

Why 2%?

In the inflationary period of the late 70s and early 80s, inflation was high and central banks around the world tried to ensure stable prices using different methods (currency rates, growth of money supply, interest rates) all with the goal to bring down inflation, above 10% at the time. When inflation finally started to come down, inflation targeting became the norm, first specified by New Zealand in 1988. That meant normal interest rates would be around 4 to 5% and would be cut to no less than 2% in a recession to have the desired effect to boost the economy.

Unfortunately, central bankers did not respect their framework and cut rates to zero. This unleashed the inflation we are seeing today.

To justify their move to zero, Fed Chair Jerome Powell made a significant change to the 2% framework on August 27, 2020. The statement replaced the 2% commitment by a 2% average over time. They also added a goal of maximum employment.

What happened since and what will happen in the next few years will be material for future economic theses.

Here is an update of different prices since last summer. Remember, prices were supposed to go down in 2022.[1]

Price of (in U.S.$)	June 28, 2019	June 30, 2020	June 30, 2021	April 8, 2022	% increase over 2019
Oil (Bbl)	58.47	39.27	73.90	96.23	65%
Natural gas (Mcf)	2.31	1.75	3.65	6.39	276%
Gasoline (gallon)	1.77	1.26	2.26	3.05	72%
Corn (Bushel)	414	373	585	765	85%
Pork (lb)	0.87	0.75	1.04	0.99	14%
CRB food index	348	290	488	568	63%
Copper (MT)	5993	6015	9335	10312	72%
Aluminium (MT)	1820	1620	2552	3385	86%
Lumber (MBF)	379	436	718	893	235%
CRB index	408	360	557	633	55%
Baltic freight sea shipping	1381	1799	3418	2778	201%

Although major equity and bond markets have had a difficult start of the year in 2022, here is the performance of benchmarks since June 28, 2019.¹

Indices	Performance between June 28, 2019 and April 8, 2022 (in U.S.$)
S&P500	59.5%
Nasdaq	77.8%
MSCI World	46.3%
MSCI emerging markets	14.2%
MSCI global small cap	34.5%
Bloomberg U.S. Aggregate Bond Index	0.42%

Looking at the above returns would signal that bond and emerging market investors, who both have a deeper perspective on the risks of inflation, have a gloomier assessment of long-term inflation risks.

But let us come back to our 3% long-term inflation rate. Why will future inflation be higher than what we experienced in the last 30 or so years?

The consumer price index (CPI), which is the main measure of inflation, is organized into dozens of categories; the most important are:

• Shelter (32.4%)
• Food (14%)
• Transportation (14%, excluding motor fuel)
• Energy (7.5%)
• Medical care services (7%)
• Education and communication services (6%)

Another measure of inflation is wage growth. In the last year, wages were up 5.7%, below inflation at 7.3%. We argue that, going forward, wage growth will be above 3%, not dissimilar to the wage-price spiral of the 70s, whether it is deglobalization and reshoring, the millennials entering the work force, baby-boomers retiring, and wages going up.

We can see from the CPI categories that shelter is the largest component. With the rise in home prices, rents have not been far behind. 

National real estate brokerage Redfin showed January’s average asking rents for housing went up 15.2% from last year. There is a lag between when rent increases occur and when they show up in the index, which is typically 18 months. This means that shelter inflation will be much higher in the months ahead.

The second largest component is food. Typically more volatile, and excluded from the core CPI number, we believe that food prices will be higher in the future than they were in the past. From the decline in arable land, to more extreme weather events, to rising input costs, we can expect higher food prices. The last spike in 2011 brought extreme unrest around the World (Arab Spring).

Costly Food

What do we think today? How do we position one’s portfolio? How will equity markets react to these higher inflation numbers and higher interest rates?

Past episodes have shown that long-duration assets, such as long-term bonds and high growth stocks, will be most affected.

U.S. large cap, particularly technology companies, are selling at important premiums to other markets. They will be most vulnerable.

Japan and Europe do not have the same inflation pressures. So inflation there may be more contained. Smaller companies have generally outperformed in periods of inflation.

From January 1979 to July 1983, the Russell 2000 outperformed the S&P 500 by 77%. During this time, inflation rose to as high as 13% and the economy suffered a double-dip recession in 1980 and 1981-82, before staging an extremely strong recovery in 1983 with growth rates as high as 8.5%.

Our portfolio is well positioned for a strong recovery, accompanied by higher inflation.

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[1] Bloomberg

On April 10, people in France will go to the polling booths for the first round of national voting. Assuming there is no majority, the two candidates with the most votes will proceed to a run-off two weeks later with the winner being declared President.

According to opinion polls, incumbent President Emmanuel Macron favored to win the upcoming election and be re-elected. Macron’s had a bit of a rollercoaster over this term, pushing through some reforms, such as facilitating the process for companies to fire workers, cutting corporate taxes and introducing new security laws to tackle terrorism. On the other hand, a proposed fuel tax in 2018 was abandoned after protests by the “gilets jaunes”, and the Covid-19 pandemic hampered a pledge to reduce the unemployment rate to 7% by 2022. Russia’s invasion of Ukraine has increased Macron’s popularity, placing him in a prominent role as a liaison to Vladimir Putin and boosting his image as a statesman who represents France well internationally – one of his key strengths compared to his rivals. 

Marine Le Pen, who was runner-up in the last election, has once again emerged as the closest rival in the first round. While the family name is associated with the far-right in France, Le Pen is no longer considered the extreme right vote with the emergence of Eric Zemmour. This will dilute her votes somewhat. Le Pen continues to campaign on a consistent anti-immigration message, proposing a referendum on restricting immigration. Once an admirer of Russia’s Putin, Le Pen has condemned the invasion of Ukraine. 

Of the other prominent candidates, the far left is represented by Jean-Luc Mélenchon. He is a staunch critic of Macron and has some opposing views, such as lowering the retirement age by two years to 60 and promising a big rise in the minimum wage. His support has declined over the past month due to a more lenient stance on President Putin and a desire to leave NATO. Valérie Pécresse, a centre-right candidate, was once seen as the strongest opposition to Macron but has fallen away as the campaign advanced. On the far-right, and eating into Le Pen’s votes, is Éric Zemmour. His campaign is built on a more hard-line nationalism than Le Pen, having previously blamed his perceived decline of France on immigration and Islam. His popularity has declined as he unveiled some severe proposals, such as deporting 100,000 immigrants each year, particularly those from North Africa.

If we look at Macron and Le Pen as the two most likely to advance to the second round, the largest differences are in immigration rather than economic policy. However, pension reform is one area where they disagree. Macron wants to increase the retirement age, while Le Pen opposes. Macron may get the benefit of the doubt here as some of his reforms are starting to bear fruit, and the potential growth of France is now above Germany’s.

France has also fared relatively well during Covid and the recovery, with the country’s real GDP above that of the larger Eurozone. One of the reasons for the outperformance, especially against Germany, is the lower exposure to manufacturing and the impact of a challenging supply chain dampening German growth. The French economy should also be less impacted by the Russia/Ukraine war as it relies more on nuclear power compared to Germany’s dependence on gas and, in particular, Russian imports.

One area where Macron and Le Pen (and most of the leading candidates) are in agreement is the expansion of nuclear power. The percentage of energy derived from nuclear is already significantly higher in France than elsewhere in Europe, and the direction being taken until recent events was to reduce this. However, Macron is considering building eight more nuclear reactors in addition to the six announced recently. Another point in common is an increase in military spending. Public spending will come under some scrutiny, as French public debt has risen well above 100% of the GDP. There are potential savings from further reductions in public employment and raising the retirement age, both of which Le Pen opposes.

Macron has implemented some measures to mitigate surging energy prices, but increasing purchasing power for households will be a hot topic. Macron wants to raise the threshold for bonuses paid to low-paid workers to be tax-free, while Le Pen prefers to slash social security contributions and increase financial aid for families.

In June, once the presidential situation is resolved, French voters return to the polls to elect a new parliament, which means a new prime minister. The prime minister is appointed by the president but has to reflect the majority in parliament, so the key question is: will the president and the majority of members in parliament come from the same party? If so, it is easier for the president to execute their policy agenda more easily. If not, a situation called cohabitation comes into effect, limiting the ability of the president to implement their agenda. Cohabitation has happened three times.

While there has been no consistent market reaction over recent election outcomes, one would think that given the recent relative outperformance of the French economy, some stability would be welcome from investors. Global Alpha currently has three French holdings in our International and Global strategies. 

Rothschild (ROTH.FP)

Rothschild is one of the world’s largest independent financial advisory groups. The company is a global leader in M&A advisory, especially in Europe, but is strategically diversifying by building wealth management and merchant banking franchises to give more recurring earnings. Some companies don’t have the internal expertise when considering M&A strategy or some form of restructuring so they reach out to Rothschild, who give an independent opinion, which is an important differentiating factor. Rothschild helps clients choose how best to approach a potential sale/ issuance/ restructuring, and may help them to select other banks (that have more developed equity and debt capital markets capabilities) to handle the transaction mechanics. The wealth and asset management franchise is mostly a European business, focusing on high net worth individuals (>€1 million in France and >€5 million elsewhere). The merchant banking franchise is present in both; Europe and the United States (U.S.), focusing on private equity and private debt with a specialization in health care and technology.

Sopra Steria (SOP.FP)

Sopra Steria is a leading European IT services company offering consulting, digital services and software development. The company aims to help its clients in their digital transformation journey by speeding up changes in client business models, internal processes and information systems. In 2021, spending on digital services reached $318 billion, with the market expected to grow over 5% through 2025. Most of Sopra’s revenues come from consulting and systems integration. The government and public sector account for the largest share of revenues at 26%.

Lisi (FII.FP)

Lisi is an industrial company specializing in the manufacture of components for the aerospace, automotive and medical sectors. For aerospace, which accounts for 48% of group revenues, Lisi manufactures fasteners, assembly and structural components for the largest players in the sector. The division has been deeply affected by the pandemic but appears to be entering a new growth cycle as the production of single aircraft, in particular, seems to be ramping up. For automotive, Lisi provides metallic and plastic assembly solutions and safety-mechanical components for global OEMs and Tier 1 suppliers. The division has recovered well from the 2020 lows but continues to be challenged by supply chain constraints. For medical, Lisi manufactures implants and other instruments. Minimally invasive surgery that was delayed during the pandemic is resuming in hospitals.

At the time of writing, the most recent opinion polls have seen the gap between Macron and Le Pen narrow. Some of them even to within the margin of error. This has seen French equities underperform as the risk of a Le Pen victory increases. So if Macron does succeed in being re-elected, as the polls still suggest he would win in a second round against Le Pen, we could see a small catch-up rally in French equities.

Mobility is essential to our daily life and economic growth, yet moving people or goods from place to place has a great impact on the environment. In the United States (U.S.), the transportation sector is the largest emitter of greenhouse gas (GHG), accounting for 27% of total emissions in 2020, with the largest contributors being passenger vehicles (41%), followed by freight trucks (26%), and light-duty trucks (17%).

Globally, the transportation sector accounts for around a quarter of CO₂ emissions, with road transportation, including cars, trucks, buses and motorbikes alone accounting for nearly 18%.[1] From 1990 to 2019, emissions increased by 20.9%. Although emissions declined 13.7% from 2019 to 2020 due to less travel caused by the COVID-19 pandemic,[2] it has rebounded almost to 2019 levels in 2021.

Transport demand is expected to continue to grow across the world in the coming decades as the global population grows and travel demand increases. In the Energy Technology Perspective report[3], the International Energy Agency (IEA) predicts that global transport demand will double, car ownership rates will increase by 60%, and demand for passenger and freight aviation will triple by 2070. This is expected to result in a significant increase in transport emissions. To achieve carbon neutrality by 2050[4], technological innovations are needed to offset this rise in carbon footprint.

Road freight contributes about a quarter of the transportation sector emissions, and heavy-duty trucks emit 20 times the amount of emissions in comparison to passenger cars. Companies are tackling the problem by modifying their fleet of vehicles. Renewable Natural Gas (RNG) is currently one of the most economical and impactful ways to achieve this objective. It is the only available renewable energy source that is carbon negative. GHG emissions from the production and use of RNG are 90% less than diesel.  

Clean Energy Fuel (CLNE US)

Clean Energy Fuel, a holding in our portfolios, is a leading renewable energy company focused on the procurement and distribution of RNG and conventional natural gas. Of its natural gas sold, 74% is from renewable sources. The company has been in the alternative vehicle fuels industry for over 20 years and is the largest U.S. provider of RNG for commercial transportation. Sales of its RNG has increased from 13 million gasoline gallon equivalents in 2013 to 153 million in 2020. In 2020, the company provided fuels to over 4,000 heavy-duty trucks in the U.S. and provided 45% of the RNG used for transportation fuel in the country. The importance of RNG is being recognized by big players in the energy and logistics industries, and Clean Energy Fuel has secured multiple partnerships, including with Amazon.

Hexagon Composites (HEX NO)

Another holding in our  portfolio, Hexagon Composites is a global leading provider of natural (renewable) gas vehicle fuel systems and gas transport modules, with an 80% market share in North America and 50% market share in Europe. The company also owns 75% of Hexagon Purus (HPUR NO), a world-leading provider of Type 4 high-pressure hydrogen cylinders, battery packs and drivetrains for fuel cell electric and battery electric vehicles. In 2020, Hexagon’s solutions avoided the release of 730,000 metric tons of CO₂ equivalent. To put that in perspective, it equates to removing 158,000 petroleum cars from the road for a year or planting 960,000 acres of forest.[5]

Passenger vehicles account for over 40% of emissions in the transportation sector, so it’s no wonder the automotive industry has been under pressure from governments and societies to pursue more sustainable growth. Electric vehicles (EV) have emerged as a key area to boost the sustainability efforts of automakers. Volkswagen targets half of its sales to be electric by 2030. Ford aims for 40%-50% of its sales to be electric by the end of the decade. The EV market has been growing rapidly, though from a small base. In 2019, 2.2 million electric cars were sold, representing 2.5% of global car sales. In 2020, electric car sales rose to 3 million, representing 4.1% of total car sales. In 2021, electric car sales more than doubled to 6.6 million, close to 9% of the global car market.[6]

Except for electrification, many other solutions help reduce the emissions of the automotive industry.

Motorcar Part of America (MPAA US)

Motorcar Part of America, a holding in our portfolios, remanufactures and distributes aftermarket automotive parts by reusing and reconditioning previously used core units that would otherwise end up recycled or disposed. With the potential to cut material and energy consumption by up to 95%, remanufacturing is the most efficient and sustainable process for producing aftermarket replacement parts. MPAA sells over 36,000 stock-keeping units (SKUs) in over 25,000 retail outlets in the U.S. and Canada. The current population of light-duty vehicles in the U.S. is approximately 281 million. The average age of these vehicles is around 12 years and is expected to continue to grow, in particular during recession years. The aged vehicle population provides favourable opportunities for MPAA.

Although the sustainability focus is primarily on fuel and exterior components, the interior cannot be neglected either.

Seiren (3569 JP)

Seiren, another holding in our portfolios, manufactures advanced materials mainly for automotive, electronics, high fashion, building and medical industries. It is the global leader of car seat materials, with a 17% market share. Synthetic leather car seat materials have been taking market share from genuine leather, as consumers and carmakers favour cruelty-free materials. Seiren’s superior synthetic leather product, Quole, feels like leather, but is only one-third or half the price of genuine leather; it is also 50% lighter, reducing the weight of a car by around 2kg. Production of the materials cuts CO₂ emission by two-thirds, and the material is four times more durable than genuine leather. Thus, it has been increasingly adopted by automakers, especially electric car manufacturers.

At Global Alpha, meeting companies and on the ground research are important parts of our investment process. Being conscious of the environmental impact, we have started offsetting our own carbon footprint from corporate travels since late last year. We will provide more details in future updates.

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[1] https://www.bbc.com/future/article/20200317-climate-change-cut-carbon-emissions-from-your-commute

[2] Inventory of U.S. Greenhouse Gas Emissions and Sinks: 1990-2020

[3] Energy Technology Perspective 2020, IEA

[4] https://www.un.org/sg/en/content/sg/articles/2020-12-11/carbon-neutrality-2050-the-world’s-most-urgent-mission

[5] Hexagon Composites Annual Report 2020

[6]https://www.iea.org/commentaries/electric-cars-fend-off-supply-challenges-to-more-than-double-global-sales?utm_source=SendGrid&utm_medium=Email&utm_campaign=IEA+newsletters

The most recent Intergovernmental Panel on Climate Change (IPCC) report outlines the stark reality in which significant resource preservation, namely land and sea, is needed to protect our species and biodiversity.

It is estimated that up to 3 billion people worldwide could face water scarcity as a result of global warming. Demand for water will exceed supply in 30% of the world by 2050 if no action is taken. Already, half of the world is presently faced with water scarcity for at least one month out of the year. Issues facing communities include poor access to water, which may be a result of a lack of freshwater sources or the lack of infrastructure due to economic conditions. Another key variable to consider is water quality. With increased industrial and human activity, water quality has been deteriorating in many parts of the world. This can be seen through effects such as ocean acidification, increasing temperatures, and increased run-off of pollutants. Hence, the importance of monitoring water quality. Regular monitoring allows for the early identification of problems and changes in quality over time.

Access to clean, running water is critical to support the health, well-being and livelihoods of societies. Most recently, discussions have been focused on land preservation and restoration to halt devastating deforestation practices happening all over the world. However, water is central to so many day-to-day activities, such as agriculture, energy production and overall economic productivity. Everyone has a common interest in responding to this problem. In fact, the water-related risk is one of the more prevailing issues in The Sustainability Accounting Standards Board (SASB) Materiality Framework, making an appearance in 25 out of the 77 industry groups.

There are ways to mitigate water scarcity and improve water quality. One of the most impactful ways that can contribute to water conservation is through changing personal habits, particularly with respect to food consumption. Some of the industries which consume the most water include fruit and vegetable farming (wheat, corn, rice, and sugarcane rank highest), garment and textile production, meat production and the beverage industry. So, by making small changes in daily consumption habits, such as reducing grain and red meat intake, it can all add up to water savings.

On the industry side, there are many possible solutions. For instance, relying on wastewater recycling, reuse, and reclamation allows corporations to return fresh and clean water for use in either a closed or open loop system. Changing current distribution systems and updating existing infrastructure would help with quick detection and more efficient use of resources. On many occasions, it is a leak that can create contamination within the water supply,  therefore monitoring changes in water dynamics would help to promptly contain the problem. Continuing to improve filtration systems will play an important role, especially in developing nations. Making water safe to drink could increase the overall water supply and reduce the amount of scarcity. More specifically, for the agricultural sector, where 70% of the world’s freshwater resources go to farming and irrigation. Technological developments are particularly in need in this sector, and solutions such as sustainable agriculture and vertical farming can help reduce the amount of water needed for food production.

Water has rarely been a trendy investment theme, especially given the current spotlight on the energy transition sectors. The lack of metrics surrounding water has made it difficult to incorporate, let alone measure, risk and opportunity within this sector. Global Alpha currently has exposure to two companies involved in water management, which provide solutions to the aforementioned problems.

Daiseki

Daiseki is the largest Japanese processor of liquid industrial waste. The company is currently the number one player in Japan, holding about 10% of the market share. In 2018, they released their Vision 2030 plans, which included an ambitious goal of becoming the number one recycling company in Asia and making a positive impact on the United Nations’ Sustainable Development Goals. Recently, an increasing amount of customers are relying on Daiseki to treat their wastewater, with demand mainly driven by carbon neutrality and circularity goals. Their wastewater processing involves separating the water from the contaminants, at which point the water is treated and released back into the river or the local sewage system. Due to growing interest in water treatment services, the company has plans to expand its water treatment capacity at their Kansai Facility. We not only see this as a positive for the company’s bottom line, but also in terms of contribution to the Sustainable Development Goals.

Primo Water

Primo Water distributes bottled water and filtration solutions to customers all over the U.S. and Europe. They are also the leading provider of self-service refill drinking water and water dispensers in Canada and the U.S. The company is focused on giving access to high-quality, purified water to its customers. Having clean and reliable water is of great importance to their customers, and Primo is able to cater to their needs with its numerous distributions solutions.  Environmental stewardship is one of the company’s key pillars; in fact, they are committed to ensuring that their water is sourced responsibly. This is demonstrated through their commitment to receiving certification from the Alliance for Water Stewardship (AWS) for all their key spring sources by 2025. Some of the objectives of the AWS are to promote better water governance, ensure good water quality and provide access to water, sanitation and hygiene for all.

As more opportunities become available in this specific sector, we will continue to evaluate attractive companies that positively contribute to tackling this issue.

When you think about banking in emerging markets, it may conjure images of long lines outside banks under the tropical sun. Surprisingly, it has been a rather short road from the long lines of yesterday to the super apps of today. For example, it’s not uncommon now to see street side hawkers in China and India accepting payments via apps as deftly as they handle their cast iron woks. Unburdened by the shackles of high cost legacy financial infrastructure, emerging markets have been faster, leaner, and more efficient in building the new age pipes that move money from point A to B.

There are three key reasons for this lightning pace of technology adoption.

• Firstly, in the absence of a traditional brick and mortar banking network, the pace of adoption has been exponential. EM consumers have leapfrogged credit cards and traditional bank-to-bank payments to mobile-based transactions.

• Secondly, emerging markets themselves have been open to collaborating with each other when it comes to sharing infrastructure and regulatory best practices via fintech bridges that connect fintech hubs like Dubai, Nairobi, and Singapore.

• Finally, emerging markets offer the size and scale of the population required to encourage fintech startups to innovate and roll out new products.

The result of this fintech innovation and rapid penetration of mobile internet has been the rise of digital payment platforms, such as Paytm in India, GoPay in Indonesia, and M-Pesa in Kenya. Similarly, we have seen the rise of digital banks, like WeBank in China, Next Bank in Taiwan, and Kakao Bank in South Korea. Another differentiating factor in emerging markets has been the proactive intervention of governments in building the infrastructure that makes payments low cost and frictionless. In Brazil for example, there is PIX, an instant payment and open banking infrastructure. In India, we have the Unified Payments Interface (UPI), which is a real time, identity-based payment infrastructure.

A great result of this blistering adoption of fintech is the tradition of gifting red packets or envelopes called “Hongbaos” during the Chinese New Year as a blessing of good luck.According to WeChat, in 2019, a staggering 820 million digital Hongbaos were exchanged during the New Year. At Global Alpha, we are both excited by and aware of the disruption that is being caused by fintech to traditional financial incumbents in banking, payment processing, insurance, and investments.

In identifying investment opportunities, it is particularly relevant for us to understand how traditional banking incumbents are adapting to competition in digital banking.³ Let us take emerging markets in the Asia Pacific as an example where the share of consumers using digital banking has risen from 54% in 2017 to 88% in 2021 according to a McKinsey report. That’s a growth of 1.4x over 5 years.

Similarly, while over 70% of consumers in these countries are interested in using digital channels to access banking services, only 20-30% of them have actually made a purchase via these channels. This is a huge untapped opportunity for traditional banks to reach consumers in the comfort of their homes while offering them their full suite of products and services.

In this rapidly shifting landscape, we evaluate how traditional banks are shifting to an omnichannel approach by leveraging digital channels for everything from transactions, customer acquisition and retention, and cross-selling to improve the productivity of existing branch infrastructure. On the other end of the spectrum, we also look at new digital-only banks and how they are leveraging technology to offer a different value proposition to consumers.

We ask the following questions while evaluating opportunities in this space:

• Do they have a unique proposition to make banking services more accessible and affordable? It’s not just about a sleeker interface and new branding. The rubber meets the road in seamless onboarding, friction-free purchasing experiences and high-quality customer service.
• Do they offer the full suite of products and services that traditional banks offer?
• Are they catering to underserved segments ignored by big banks? These segments offer the critical mass necessary for quick scalability.
• Do they have experienced leadership with a plan towards a clear path to profitability? An experienced team knows how to leverage data for accurate targeting and product pricing while still deploying a robust risk management framework.

Banco Regional (RA MM)

One of our holdings that is looking to leverage opportunities in this space is Banco Regional in Mexico. Banco Regional focuses on banking for the small and medium enterprises (SME) segment. Banco Regional made a successful foray into the consumer segment by targeting the high net worth segment and more recently, it has decided to target the mid/low-end consumer with a fully digital offering called Hey Bank. With over 500 programmers on their payroll, Hey Bank has built an offering that is easy to use and full of convenient functionalities. Their mobile app allows customers to open an account in just five minutes. We like the fact that Hey Bank pursues profitable clients and is expected to break even by 2022. At Global Alpha, we continue to look for opportunities at the intersection of finance and technology that tap into the growing financialization of emerging economies.