Innovation: Employing “Work from Home” Stocks in a Growth Portfolio
VOICEOVER: Welcome to Lord Abbett’s Market Update. I’m Tony Fisher.
[AUDIO SNIPPET]The work from home businesses are all riding the tailwinds of the technology revolution, specifically the phenomenon of conquering distance, space, and time.
VOICEOVER: Are you listening to this podcast in the comfort of your home office? If so, you may be part of a growing cohort of people now working from home during the pandemic. What are the investment implications of this momentous shift? We’ll examine the topic in the first installment of this two-part podcast, which features a wide-ranging conversation with Lord Abbett Partner Thomas O’Halloran, who heads the Firm’s Innovation Growth Equity team. We’ll kick things off with a question from Lord Abbett Digital Editor Will Andrews.
Will Andrews: Tom, you said that one of the most important issues in the equity market today is whether work from home, or WFH, stocks will continue to outperform cyclical stocks, or whether we're in store for a big reversal of this trend? So which do you prefer: WFH stocks? Cyclical stocks?
Thomas O’Halloran: Well, as innovation growth investors, we prefer the work from home stocks. We think that they're posed to outperform dramatically over the intermediate term and the long term. Their outperformance has been significant since the onset of COVID-19. So one has to be open to the possibility that there could be a reversal of this trend. And there are reasons to be bulls-- and bears-- on WFH stocks. But we're holding what we have and think that the outlook is quite good for them.
Andrews: What do you mean by the “WFH stocks"? Maybe give us a definition of those stocks that are most benefiting from that trend?
O’Halloran: By "work from home" we mean a very broad-based term. These are companies that are enabling and benefiting by the movement of commerce, communication, and collaboration to more dispersed locations. Associated with this is the dramatic reduction in the need for physical movement of people to central locations to engage in these activities.
The work from home companies tend to be clustered in areas such as e-commerce, cloud computing, and social networks. And many of these span different industries. For an example, specialized telephony software not only enables better work communication, it also is now replacing trips to health care providers through telemedicine.
The key is that the work from home businesses are all riding the tailwinds of the technology revolution, specifically the phenomenon of conquering distance, space, and time. And all of this is very deflationary because the use of physical energy and goods is being reduced. All of this is also very destructive, leaving many old businesses in grave danger of extinction.
Andrews: What exactly did the pandemic do for these stocks, or to increase the adoption of their services?
O’Halloran: Well, it's not an understatement to say that COVID-19 changed the world for WFH stocks. Because it accelerated the technology revolution and set the stage for dramatic market share gains for these companies and their stocks. Since COVID-19 began wreaking havoc on the equity markets, in late February, WFH stocks have dramatically outperformed cyclical stocks.
The pandemic forced us to conquer distance, space, and time. For the first time ever we were able to do it. And that's the key. Back in the year 2001, when we had a previous crisis, the terrorist attack [on September 11] we were not able to do videoconferencing like we can today. So interpersonal communication was all by text and by voice. And it wasn't as good as the real thing.
And with things like videoconferencing and e-commerce and social networks, we have been enabled to stay afloat during this crisis. We've had a forced recession accepted as the price for taming the pandemic. And that has really slammed economically sensitive businesses, in some instances permanently maiming them.
So it was really that COVID-19 forced us to separate. And for the very first time, the technology revolution had allowed communication and commerce to occur as if we were in the same physical space. And that was a real game-changer. And that will endure.
Andrews: So, Tom, it's interesting you bring that up. Because there are those who say that there could be some sort of rotation back into cyclical stocks at some point-- you know, given that, you know, the WFH stocks have seen tremendous gains and that some people are probably guessing that there will be a return to something resembling "normal" as we knew it before the pandemic. What’s your response to that?
Both have well-reasoned arguments. I believe, as a bull on WFH stocks, that the pandemic has permanently changed the economic landscape, driven mainly by the technology revolution.
And I think that these work from home businesses will continue to grow for years and keep scaling to higher levels of profitability. So I expect they are going to remain dominant for the decade. Other investors believe that the cyclicals have been priced for despair, and that things will return toward normal activity over the next few years. And if so, they believe cyclicals could crush work from home stocks as the latter flatten out or correct after big moves.
Oftentimes, when stocks have big moves-- they consolidate the gains for a period of time either going sideways or going down for some period of time. And if that happens to WFH stocks while cyclicals are rebounding off of depressed levels, cyclicals could outperform WFH.
The future's likely going to unfold somewhere between these opposing views. But to help us envision what lies ahead, we really need to consider the origins of WFH businesses, the key developments that have enabled their dramatic outperformance recently, why this pandemic specifically accelerated those trends, and why these can persist and expand.
Andrews: So-- it's interesting. So you are here with me on this call on a service called "Zoom," along with our audio wizard, Tony Fisher. How did this all become possible? How did the work from home technologies and the whole impetus behind this trend come about?
O’Halloran: It's been unfolding over the past 60 years, primarily. We've been on the planet for far more than that, as you know. We have had-two major revolutions that changed the nature of life. The first was the fossil fuel revolution in the 18th century. And this may be considered "the revolution of the muscle." We found a way to ignite dense material to create human energy equivalence. This enabled longer lifespans, nice things like toilets and showers and air conditioners and cars.
And now, however, "the revolution of the brain" is taking over, the technology revolution. I say "the revolution of the brain" because the tech revolution has been marked by exponential processing gains. Processing is a brain function. And these processing gains, which have been relentless over the past 60 years, have been translated in a free market economy by entrepreneurs into multiple new commercial opportunities across a wide swath of industries.
And many of these have now converged to overcome the former constraints of distance, space, and time. And that is the main initial huge investment opportunity of the technology revolution and that is the key to understanding why the tech revolution made WFH possible.
The second aspect of the technology revolution, which is replicating our brain--think Google--has begun and will unfold well beyond this decade. But for now, the key is how is the brain being used to overcome the costly human constraints of distance, space, and time? And it's not just a hard cost, it's also an opportunity cost that could be better taken advantage of if we can overcome these things.
Now, incredibly, most of this has happened over the past 60 years. And it's also critical to appreciate that with each passing year, the force of the technology revolution has grown because there have been exponential processing gains. When I started at Lord Abbett in 2001, $1,000 of computing power bought you the equivalent of an insect brain. In 2023, $1,000 of computing power is going to buy you the equivalent of a human brain.
That's quite extraordinary. And it started, really, gathering steam in 1960, when Intel created the microprocessor, which had the effect of enabling multiple electronic devices to be combined into one device. A couple of decades later, the Microsoft Operating System had brought computing power to a window on a desktop that we could sit down and work on and do many other things.
And this ushered in a new force: software. Now, software is even more brain-like than electronic circuits because it's based on instructions that are repeatable, brain-like instructions. And this elevated the technology revolution, software did, from the physical to the virtual realm.
And that all led to a personal computer boom over the next decade. And then we had these things called "routers" that tied all of the computers together in the early 1990s. When I started in the business, and showed up for my first day of work, in 1988, my computer plugged into the wall and connected with nothing else.
And then, all of a sudden, these routers started showing up in the water room, and we tied all of the computers together by the end of the 1990s. And that made Cisco a gigantic stock. And then wireless networks, enabled by companies like Qualcomm, at the same time began to tie all devices together wirelessly. But what could get through these wireless networks was not a lot of information. That was ahead.
And then the big one happened in 1995 when the United States Government opened up the internet to commercial opportunities. And this unleashed a gold rush of new opportunities. And the three key enablers that came out of the initial internet gold rush of the WFH phenomenon were: e-commerce, cloud computing, and social networks. And these have continued to expand dramatically over the past 15 years, and we think they'll continue to expand dramatically.
Andrews: Let's maybe delve into each one, you know, the opportunities and some of the considerations within those three areas that you talked about: e-commerce, social networks, and cloud computing.
O’Halloran: Well, I'd start by saying that they all began in the 1995 to 2005 decade. E-commerce got off to the first start. And cloud computing and social networks followed soon thereafter. And they now represent enormous markets. And each of them has been what has enabled work from home. And each of them has many work from home constituents.
And all three benefited from this new resource, which is processing that was now growing in abundance. Think of it as the densely packed matter was the raw material, the new resource of the fossil fuel revolution. But it was scarce. This resource, processing, is in abundance. So that is why the tech revolution is much more powerful than the fossil fuel revolution.
But starting with e-commerce, [this technology] converts a physical interaction to a virtual one. Of course, it can't be all virtual. We have to get the goods from where they are made to the consumer. But multiple steps in the process are eliminated by e-commerce.
And this brings about a dramatic reduction in resource requirements and immense convenience to the consumer who saves distance, space, and time. For what used to be a hundred trips to the mall, let's say, now there are maybe ten. That's a dramatic reduction in the use of physical resources. And by reducing resource requirements, e-commerce is a deflationary force.
Social networks: One of our most basic needs, as humans, is to communicate. The telephone was one of the major developments that came out of the fossil fuel revolution. Initially, communicate required face-to-face interaction, physical interaction. The telephone made remote communicate between two people possible.
Now, shortly after the turn of the current century, a new mechanism arose by which multiple numbers of people could communicate simultaneously, billions of people at once-- social networks. That was a huge breakthrough. And guess what? They're free because they can be supported by advertisement. So usage has naturally exploded.
Now, they're great for communication. But they have a lot of bad things about them, social networks do. They are a platform for hate speech. That's not a good thing. They engender unproductive economic activity. I don't have a social network account, I don't go on one. Because I don't think it's very productive for me to do so. But billions do.
And so these are very large and powerful entities and, you know, maybe there'll be different ones in the future, but the phenomenon of a social network, where multiple can communicate effectively in one place, is here to stay. And that enables a lot of great work from home businesses.
Now, cloud computing: This really is maybe more powerful than e-commerce or social networks because it's directly leveraging software. And what it has done is it has really enabled us to move from the physical realm to the virtual realm. So work moves from the physical realm to the virtual realm. So does communication. So does commerce.
Initially, our software had to be distributed to match physical needs. So that when I started in 1988, the software that ran my firm was in the basement. And it was in the basement of every building in New York City: tens of thousands of buildings.
Then, around the year 2000 to 2005, in that 1995 to 2005 sweet spot, the tech pioneers realized they could "host" the software in one place. And it became called "the cloud." This was a game-changer, enabling software to become much, much more powerful, because you could now continuously upgrade it. You could now make it specialized. You could now charge on an annuity-like revenue basis, meaning your business was more stable and therefore more valuable. And it really is what has formed the basis, more than anything, of our ability to share text, voice, and video communications. Which completes the requirements for interpersonal equivalency. So cloud computing eliminated distance, space, and time more than anything.
Now, realize that a text communication requires a much smaller amount of information to be processed than a video one does, dramatically less. And that is why it took time for the wireless networks to get to the point where they could handle that substantially higher data requirement to enable us to distance like we have during this crisis. We could have never done this in 2001, after the terrorist attack. We could have never done this to this extent as recently as 2008-'09, when we had the global financial crisis.
Andrews: So the pandemic—let’s reference that, especially the comparisons with the 9/11 terrorist attacks and the economic impact. How is the pandemic different than those terrible events of 2001? Give us some of your thoughts on that.
O’Halloran: When you hear the debates about whether work from home stocks will continue to outperform cyclicals, the references are often made to September 11, 2001, and the great financial crisis of 2008-09. And this leads many to believe that we will "bounce back" from it like we did then.
I think this one is very different, mainly because it is likely to be of much longer duration. The September 11, 2001, terrorist attack, which I saw from my office window across the river, was much more physically dramatic. It was scary. It was right in your face. And that did lead to many changes.
There was a lot of harm to Lower Manhattan. But it didn't take long for people to realize that this was likely a one-time event. We were unlikely to have planes going into buildings in New York City, or any of our large cities, again any time soon.
So life returned to normal, and mobility continued its march forward. And when I say "mobility continued its march forward," let me just digress and point out that one of our basic needs as human beings is to be mobile, because we're social animals. And so the technology revolution enabled commercial opportunities to make us more mobile. And we continued back on that path shortly after 2001.
The great financial crisis was very different. That was primarily a financial crisis, per se. And it did wipe out huge wealth. But it was resolved, more or less, in six months, by printing money to bail out the financial system. The aftereffects have lasted to this day, but we did truly "bounce back" from these two events that occurred over the past decades.
I think COVID-19 likely has a much longer life than either of these two. It's shrouded in mystery. We don't even know how it started. We don't even know how long it will live. We don't know whether it will give rise to other, similar viruses.
We do know that it is a virus that has a much greater sting than anything we've seen before. But it's likely to be around for at least a year or two, or more. I would think, you know, for the next year, it's unlikely we'll have a vaccine that everybody can take and feel safe.
And even after we get a vaccine, and people feel safe, there's the likelihood that something like this could happen again, and a very plausible likelihood. We can't really solve this problem, this health problem, by printing money like we did in the great financial crisis. Although we have certainly done that to tide us over this chasm brought about by a forced economic recession, to try to tame the pandemic.
And in the process, businesses have been destroyed: restaurants, travel businesses, things like that, retailers. They're done. They're down for the count. They're not getting up. And in that sense, it's more like a depression rather than a recession.
Income inequality has been exacerbated in a bad way, by this. Because lower incomes are underestimated in the work from home economy. So I think this pandemic is very different than September 11 and the GFC. And will likely last longer in its economic impact.
VOICEOVER: In the second and final part of this podcast, we’ll pick up the conversation by delving into the question of growing inequality and other potential downsides of the work-from-home-boom, along with an inside look at how Tom O’Halloran and his team balance social and other factors while making investment decisions. We’ll also get Tom O’Halloran’s view of the longer-term prospects of the work from home stocks as technology, business, and society evolve. Stay tuned and stay up to date at lordabbett.com. Subscribe and rate us on Apple Podcasts, Spotify, or your favorite streaming app of choice. Thanks for listening.________________________________________
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