Work from Home” Stocks: A Performance Review | Lord Abbett
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Equity Perspectives

Lord Abbett Portfolio Manager Thomas O’Halloran explores the pluses and minuses of the “WFH” phenomenon and sums up the long-term investment prospects of related equities. Second of two parts.

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Transcript

VOICEOVER: Welcome to Lord Abbett’s Market Update. I’m Tony Fisher.

*music hits*

[AUDIO SNIPPETS]

And if that weren't enough, they are much better business models.

However, there is a dark side to all of this-

VOICEOVER: In today’s podcast, we’ll conclude our wide-ranging conversation on the so-called “work-from-home” stocks with Lord Abbett Partner Thomas O’Halloran, who heads the Firm’s Innovation Growth Equity team. In part one of the podcast, Tom outlined the trends that have propelled the large-scale adoption of remote work. Here, we’ll look at some of the other market and economic implications of this trend. But first, I had questions for Tom about two timely topics—the increased scrutiny of the “big five” tech firms (Facebook, Amazon, Microsoft, Apple, and Google), and the potential downsides of the advances in technology that have enabled working from home. *audio ends*

Tony Fisher: You know, we talk about the "tech revolution," but there's also a significant human cost. And I wanted to get your opinion about that. You know, what does this mean from the ground up? What does the tech revolution look like for, say, the frontline worker or the delivery person, you know, from the ground up?

Thomas O’Halloran: That's a great question. And I'd start by saying that the technology revolution is not all good, by any means. The technology revolution brings with it a lot of destruction and a lot of bad things. The good of the technology revolution is quite clear, you know? One cannot really argue that if we conquer distance, space, and time, to some degree and if we can replicate our brains to free us up for other activities, that is clearly a good thing.

However, there is a dark side to all of this--namely, that it is displacing many businesses. It is displacing many workers. The benefits of it in this crisis have been very unequal. People who are on the front line who must deliver the goods pay the price by having to deal with dramatically higher demand that is very stressful for them to handle.

The large five tech companies have had to compete to try to maintain their competitive advantage. And in doing so, arguably, have crossed the line. And so all of them are under investigation, to one degree or another, for business practices, whether they be tying arrangements as might be the case with Apple's app store; or ways in which a search is altered by companies like Google.

And we as innovation investors have to watch out for when they may be on the wrong side of the law and the government damages their business. As the great investor John Templeton used to say, "When the government is getting in, investors should get out. And when the government is getting out, it's a green light for investors to get in."

So all of this technological change leaves a trail of broken businesses and bodies. And so, it's not all good. But it did tide us through this difficult time period.

Looking ahead, as the technology revolution begins to enable things like automated vehicles, well, what happens to the two million jobs which are one of the biggest job opportunities for truck drivers? Do they all lose their jobs? That might happen. I think all cars will be automated someday. I believe that that will happen further in the future than we think now. But it is it is going to cause a huge economic toll.

So all of these advances-- think of it as when you burn coal to power a utility which can enable electricity. There's a negative externality: the coal smoke spewing into the air. There are similar invisible negative externalities caused by this technology revolution which need to be dealt with.

And if some of these technology companies, which we call often the work from home companies-- if they are creating more negative externalities than the market appreciates, then that will likely come home to roost. So there is a dark side of this technology revolution as well as a bright side.

And I would say that one of the major dark sides to this, which I didn't mention, is income inequality. And the reason is that people at the top end of the income scale have greater access to the benefits of the technology revolution. They're more likely to be computer-literate.

The people at the lower end of the economic spectrum have less access, and are likely to be harmed to a greater degree than people with more income. So this technology revolution is not all good, by any means. There's a lot of bad to it. However, it is progress and I would hate to think that a world war or a government takeover of free market capitalism would put an end to it because I think it's, on balance, very good.

The technology revolution can be a very fickle friend. If we look at mobility, for example-- we're social animals. We have physiological needs, we want to be safe. But also, once we get beyond that, we want love and belonging. So dating sites are big businesses now. Pets are a huge industry because they satisfy our need for belonging.

We want self-esteem. We want other people to think well of us. And we want self-actualization. We want to "be the best we can be." And the technology revolution has exploited this phenomenon, in part by making us more mobile transforming the way we communicate, the way we work, the way we engage in commerce.

And over time, over the past 20 years, we've seen more and more economic activity become centered around crowds: airports, concerts, hotels, office towers, parks, restaurants, stadiums. Great wealth creation followed, as well as unnecessary excesses. You have to pay through the nose to get a hot dog at Madison Square Garden. All of this was, you know, not "necessary," but it was what we seemed to want.

Now, if we can catch a deadly flu by being in crowds, we didn't need that mobility. So whether you say COVID-19 or the tech revolution took away what it gave, that's what's happening.

Fisher: Yes, yes. How does Lord Abbett say, "I understand that some of the tech ideas, some of that investment, could be harmful.” How do we determine what we'll invest in order to mitigate some of that harm?

O’Halloran: I would say, Tony, that as investors in technology at Lord Abbett we look at the world and the innovation strategies in in three dimensions. First of all, we're trying to identify the best businesses to invest in, the ones that have the best managements, the best business models, the best markets, the best competitive position. So if we see things go wrong at the margin in those, we're likely to either cut a position size or withdraw the position from the portfolio, sell it.

Secondly, we monitor very carefully how well the companies are progressing toward their potential, what we call "operating momentum." And then, thirdly, and perhaps just as importantly, if not more so, is we use technical analysis to watch the progress of the stocks. Because the world is filled with investors who let their ego get in the way and hold onto positions that have long since passed their best eras or time periods. And when we see stocks going down, we typically will sell.

I would say additionally that as investors over the past couple of years, we have really stepped up our engagement with companies. We are looking more to how they are behaving as global corporate citizens. We pay attention to diversity, community activity-- how they fare on environmental, social, and governance issues.

So that has been a big change at Lord Abbett and in my strategies investing in these technology revolution companies. And so I would say, firstly, we're monitoring them very closely to make sure that they're not being overcome by the bad side of the technology revolution, either inadvertently or purposefully. And then, secondly, we're engaging with them to ensure that they drive toward becoming better global corporate citizens. All of which is synergistic and helpful to whether they're going to work out as investments over the long term.

Will Andrews: We still have to get to growth versus cyclicals question. Will this pandemic enable these "WFH" stocks, as we call them, work from home, to continue to outperform the cyclicals? Or will there be some reversion?

O’Halloran: Well, I think that-the forces that have enabled these work from home businesses, expressed mainly in the three big areas we spoke of: E-commerce, Cloud computing, social networks, are likely to continue to persist and expand.

So I think in the future, these work from home businesses will be a bigger part of the economy. And if that weren't enough, they are much better business models. They require fewer assets than older businesses because they don't produce as many physical things.

They don't solve the problem of production or transportation. Some of them have to rely upon others. Some of the E-commerce companies provide the transportation. But as they grow, these work from home businesses, they become much more profitable because their marginal investment is lower.

So in addition to the tech revolution enabling these businesses to be more flexible and adaptable, and therefore a bigger part of the economy, they're also more annuity-like in their revenue streams, and so they're much better business models.

Now, to some degree, the work from home companies are clustered in growth, while cyclicals are more clustered in value. I think growth is going to continue to beat value as the work from home companies become a more pervasive part of the economy.

Many of these value businesses which appear cheap are going to be eliminated. They're going to be worth nothing. The work from home businesses are going to take value from these. And I think value investors have been used to a world, over the past century, where things didn't change that much. And things would always revert to the mean.

And that was a strategy that worked very well for a long period of time. But now, change is not a reversion to the mean. It's for the worse. Some of these businesses that are clustered in value indices: financial services, banks, for example, leisure and entertainment, airlines, hotels, concerts, parks, manufacturing, and retail, are very, very vulnerable. They're looking at extinction.

That said, we are rebounding out of a deep, forced recession. So some cyclical stocks look very attractive and we own a number of them. Trucking companies benefit from E-commerce. Virtual real estate sites benefit from a housing recovery. Payments companies that are focused on retail benefit as retail rebounds.

So today, as innovation investors, we have many more companies to invest in that benefit from not only work from home considerations, but cyclical: both. And so, I continue to believe that growth is going to outperform value for the decade ahead by more than it did last decade.

Now, in any given year, that could change. 2016 was a year when value beat growth substantially by over 20% within a decade where growth outperformed value by a lot. I could see a scenario where, if we have a surprise in the election and Trump wins where we could have a big value rally because he will be perceived to be as the low-regulation president, and the odds of an economic recovery might be thought to be greater. And that could lead to outperformance, temporarily, of value over growth. So whether growth or value, whether work from home or cyclical, in the near term it's a good debate. In the intermediate term and the long term, I feel as though work from home is going to dramatically outperform.

Andrews: Give us a broader macroeconomic view. As this work from home world becomes vastly more efficient, more computing power becomes available, and it becomes more widespread, what does that do to inflation?

O’Halloran: Well, I think we have seen that it has lowered inflation. If we look at the inflation rate since the [inception of the] Internet, it's declined. And I think that will continue. Because the technology revolution-enabled work from home businesses are vastly more efficient and use far fewer resources.

And consider E-commerce: When only 10 people go to the mall instead of 100, you have much less wear and tear on the car, much less usage of gasoline. And there are multiple examples of that as we look at how the technology revolution has changed the society.

So in my view, this is a very powerful deflationary force. and other things being equal, a force which will enable inflation to remain low. And if inflation remains low, then interest rates will remain low. They're already very low. And if they continue to be very low, and we, at the same time, have good growth enabled by the innovation that we have today, that's very bullish for stocks. So I'm very bullish on stocks for the decade ahead.

Andrews: All right. So we've run to the end of our allotted hour.

O’Halloran: Really, thank you guys so much for this. This is this is my first podcast ever. I told my wife this is great! I've never done one of these before.

VOICEOVER: I have a feeling this is only the beginning of Tom’s podcast journey. Thanks to Tom O’Halloran for his time and insights today. Special thanks to digital editor Will Andrews for his contributions in today’s episode.

For continuing commentary on Innovation investing, stay tuned, and stay up to date on lordabbett.com. Subscribe and rate us on Apple Podcasts, Spotify, or your favorite streaming app of choice. I’m Tony Fisher. Thanks for listening.

________________________________________

Value and growth-stock performance comparisons are based on the relative performance of the Russell 1000® Growth Index, or Growth Index, and the Russell 1000® Value Index, or Value Index. The Growth Index measures the performance of those Russell 1000 companies with higher price-to-book ratios and higher forecasted growth values, while the Value Index measures the performance of those Russell 1000 companies with lower price-to-book ratios and lower forecasted growth values.

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