Autus CEO, Dominic Ilett, share insights on global and domestic macro factors in our final quarterly review of 2021.
The final quarter of 2021 provided a mixed bag of positive factors to celebrate as well as opposing negatives that continue to cause concern. A standout feature was the peaceful, free, and fair municipal elections held in November. Our maturing democracy is a model to many developed and emerging countries around the world. With the support for the ruling ANC declining, the future of SA’s politics will be anything but dull.
As we move to a “COVID-19 – new normal,” there is general acceptance that the virus could be with us (albeit mutating) for a lot longer that we would prefer. Positively, increasing vaccine rollouts, booster shots and better health management of those infected with the virus has lowered the hospitalisation rate and ultimately the death rate. As we write this report, SA is in the middle of a fourth COVID wave, but the economy has remained on Alert Level 1 with most economic activities operating unhindered (last year readers may recall that the beaches were closed over the December holiday period!). Fitch Ratings surprised the market by revising the outlook on South Africa’s Long-Term Foreign-Currency Issuer Default Rating (IDR) to Stable from Negative and affirmed the IDRs at ‘BB-,’ due to better-than-expected tax revenue collections.
SA mining companies had a bumper year as profits soared due to increased global demand for commodities and concomitant higher commodity prices. CPI inflation crept up to 5.5% in November, pushed higher by rising fuel and food prices. GDP growth turned negative for Q3/2021 registering -1.5% q/q seasonally adjusted, as the July social unrest and lockdown restrictions to combat the third COVID wave derailed the economic recovery. Forecasts are that in Q4/2021 the SA economy will show an improvement and that for the year GDP growth of between 4.5%-5% is likely. The SARB’s Monetary Policy Committee (MPC) decided to hike the repo rate by 0.25% to 3.75% at its mid-November meeting. The MPC cited inflation risk as an important factor, emphasising that the current trajectory of interest rates remains supportive of the economic recovery. Stats SA reported that at the end of Q3/2021, SA’s official unemployment stood at 34.9%.
The Organisation for Economic Co-operation and Development (OECD) warned that the emergence of Omicron increased uncertainty already weighing on global economic outlook and highlighted vaccination shortcomings. The main risk to the global economic outlook is continuous rising inflation. The global economy is now expected to expand by 5.6% in 2021 (previous forecast was 5.7%). Global growth is expected to moderate to 4.5% in 2022 and 3.2% in 2023. While the global recovery continues to progress, there are signs that it is losing momentum and is becoming increasingly imbalanced. The US Federal Reserve met in December and announced that they will reduce the quantum of financial accommodation it has been providing to markets and that three interest rate hikes are likely in 2022. They opted to remove the word “transitory” to describe inflation admitting that rising prices could prevail for longer than first thought.
Matt Maher said “In order to move forward you need to look back.” At Autus Fund Managers, you can be sure that we understand the importance of doing both.
By Francois Roux, CFA, Portfolio Manager – Autus Fund Managers
In March 2014, Facebook paid $2 billion to buy a company most of its users have never heard of: Oculus VR, Inc. Oculus is a leading producer of virtual reality (VR) headsets. The acquisition revealed an important clue about the future vision of CEO Mark Zuckerberg for the social media company he had started in his Harvard dorm room in 2004. Seven years after the acquisition of Oculus, Facebook made a much bolder announcement.
A new name for a new era
In October 2021, Facebook announced it will be changing its name to Meta Platforms. The names of the company’s apps will remain unchanged. This means that Facebook, Instagram, and WhatsApp will remain household brands for billions of people around the globe. Meta Platforms will thus become the name of the holding company for all the assets of the current Facebook. The company’s stock ticker will also change from FB to MVRS on 1 December 2021. Why exactly did they choose this name?
Meta refers to the metaverse. Before Facebook claimed the name for itself, the metaverse was already a generic term put forth as a vision for the future of our digital lives. Some consider the metaverse to be the next natural iteration of the internet. Simply put, the metaverse is an immersive, virtual space in which users can interact with each other and with objects in the virtual world. Zuckerberg describes it like this:
“When I started Facebook, we mostly typed text on websites. When we got phones with cameras, the internet became more visual and mobile. As connections got faster, video became a richer way to share experiences. We’ve gone from desktop to web to mobile; from text to photos to video. But this isn’t the end of the line. The next platform will be even more immersive — an embodied internet where you’re in the experience, not just looking at it. We call this the metaverse, and it will touch every product we build. The defining quality of the metaverse will be a feeling of presence — like you are right there with another person or in another place. Feeling truly present with another person is the ultimate dream of social technology. That is why we are focused on building this.”
Mark Zuckerberg interacts with an avatar of himself at Facebook Connect 2021. Source: Business Insider
Not only Facebook’s metaverse
Microsoft CEO Satya Nadella has also weighed in on the metaverse, stating that it can be thought of as the physical world becoming digitised. Nadella further adds that the video meetings we have all become used to since the start of the pandemic will eventually transcend into 3D immersive meetings where we interact with each other using avatars. It is not inconceivable to imagine our working lives moving into the metaverse over the next few decades. Microsoft owns several professional software tools under the Office banner including Excel, Teams, Word, and PowerPoint. The company also owns the professional networking platform LinkedIn and the Xbox gaming console. These products and services could become more immersive over time, and Microsoft has already announced its intention to introduce 2D avatars in Teams in the first half of 2022.
The frontier of immersion in digital worlds has always been gaming. Modern games resemble communities of people who view online gaming as social events where they communicate with friends and talk about their daily lives. The COVID-19 pandemic has accelerated this trend as people were locked inside their homes for months at a time with few options of engaging socially in the real world. Game developers are also increasingly focusing their resources on games that are compatible with VR headsets. The Oculus range of VR headsets are among the most popular devices in this nascent category but competing devices have been coming to the market from the likes of HTC, Sony, and Valve.
A gamer plays in her Oculus Quest 2 headset. Source: The Verge
VR is not the only way to access the metaverse through gaming. Fortnite, the popular battle royale game developed by Epic Games (in which Tencent holds a 40% stake), has featured live shows by artists who appear on stage as avatars of themselves and perform in front of millions of their fans’ avatars. It is likely that these types of concerts will eventually happen in a VR environment which will become integrated with our current gaming experiences.
Marshmello performs for a live audience of 10 million people in Fortnite. Source: NAG Magazine
Consumers appear increasingly willing to spend real money in the virtual realm. Global spending on in-game items amounted to over $54 billion in 2020, according to Statista. This means the market for items in the virtual world already exists and is set for explosive growth in the coming years. The rise of cryptocurrencies and non-fungible tokens (NFT’s) is further evidence that people are willing to spend money on virtual items which exist only in the metaverse.
Fashion brands see an opportunity
The world of fashion is not immune to technological change. Over the past two decades, apparel and footwear brands have had to adapt to the shift towards digital sales channels and changing consumer needs. The metaverse is no exception, and several brands have already indicated their intentions to capitalise on this opportunity. In October, the U.S. Patent and Trademark Office acknowledged the filing of seven patents related to the metaverse by apparel and footwear behemoth Nike. Luxury brands are also jumping on the bandwagon. A recent report by Morgan Stanley predicts a $50 billion market for virtual luxury goods by 2030. The authors of the report do, however, note that the opportunity is most likely skewed towards soft luxury goods (clothing, leather goods, and footwear) as opposed to hard luxury goods (jewellery and watches).
Virtual or augmented?
VR is not the only way in which we will experience the metaverse. Augmented reality (AR) is the imposition of virtual objects into the physical world. In contrast to VR, AR does not change the user’s whole environment into a virtual world. Instead, the user’s reality is simply augmented with digital elements. A practical example of this is the popular mobile game Pokémon Go, where players run around in the real world attempting to catch digital creatures they can only see through their phones.
An application of AR: Pokémon Go. Source: New York Times
Who stands to gain from building the metaverse?
The metaverse value chain stretches from the producers of computer hardware all the way to the designers of the software and the hosts of the platforms on which the metaverse is being built. As mentioned earlier, Facebook and Microsoft are two technology giants leading the way as platform providers to a metaverse version of the internet. The computing power necessary to power the metaverse will require the advanced graphics processing units (GPU’s), central processing units (CPU’s), and memory chips produced by the likes of Intel, AMD, Qualcomm, Apple, Nvidia, Micron, and Samsung. On the software side, game developers like Tencent, NetEase, Take-Two Interactive, Electronic Arts, and Activision Blizzard are crucial actors in the development of the virtual worlds which will form the metaverse. On a more foundational level, game engines like Unity and Unreal Engine (owned by Tencent-backed Epic Games) will provide the tools with which the metaverse will be built.
Interoperability of different platforms
One of the most important questions about the metaverse is the degree to which people and objects will be able to transfer from one platform to another. As one Bloomberg reporter sums up the problem:
“If, say, Nadella and Zuckerberg wanted to meet up in the metaverse, would they have to choose either Microsoft’s Teams or Meta’s Horizon Workroom?”
The original vision of the metaverse is one where people move freely inside a unified metaverse, which implies perfect interoperability between different platforms. To their credit, both Zuckerberg and Nadella have alluded to their willingness to collaborate on a unified metaverse, but it remains to be seen how possessive companies will be over their own domains.
The metaverse will bring technologies and applications to our lives which we have not yet been able to imagine. The race is on to build the future of the internet. Facebook, or rather Meta Platforms, has taken a head start by staking its claim in an audacious way. Time will tell who the rulers of the metaverse will eventually be.
Autus CEO, Dominic Ilett, share insights on global and domestic macro factors in our quarterly review.
The impact of political, social, and economic macro factors exerted greater influence on markets than micro factors over the quarter. Locally, the July civil unrest and blatant looting of shops, factories, and trucks in KZN and Gauteng highlighted the existing fragility where high unemployment and hardship experienced by a majority of the population is combined with disingenuous political forces. While the financial cost and losses from these events are still being tallied, the capital required to repair the damage could have been better used to fund corporate investment, growth, and job creation.
GDP growth for 2Q21 of 1.2% q/q (from 1.0% q/q in 1Q21) marginally surprised to the upside. Positive contributors include transport, personal services, and agricultural sectors. For 2021, growth of 4.1% is forecast slowing to 2.2% and 1.4% in 2022 and 2023, respectively. Real GDP is therefore only expected to reach the pre-pandemic 2019 level in 2023. Inflation was 4.9% in August and may tick higher in the coming month due to fuel hikes and a weaker rand. While the Reserve Bank is expected to keep the repo rate unchanged at 3.5% for the rest of the year, there is an increasing risk of a hike sooner should inflation data be more negative than anticipated.
Globally, the direction and pace of US inflation and global growth were top-of-mind of global investors. The US Federal Reserve signalled that they are inching closer to reducing the monthly financial stimulus of approximately US$ 120bn provided to the market. This financial tapering is widely seen as a precursor to hiking interest rates next year depending on whether higher inflation is transitory or more structural. US growth of 5.9% is projected for 2021, a reduction from earlier forecasts of above 7% as the prolonged effects of COVID and global supply constraints hinder economic progress. In Europe, the ECB indicated that they would trim emergency bond purchases in 4Q21 as high vaccination rates across Europe bolster recovery prospects. The ECB upgraded its growth forecast for this year to 5% from a previous 4.6%. Inflation expectations were lifted to 2.2% this year, falling to 1.7% next year and 1.5% in 2023 – well below the ECB’s 2% target. China had a tumultuous quarter as the government clamped down on consumer protection and anti-competitive behaviour. A resurgence of COVID-19 infections forced the lockdown of some cities adversely affecting economic activity and further disrupting the constrained supply of goods to world markets. A sharp and broad-based falloff in economic activity in July surprised to the downside with industrial production, fixed-asset investment, and retail sales growth all weakening.
Analysts expressed increasing concern about the “unbalanced” and “unstable” recovery and the mounting array of growth pressures facing the Chinese economy. We anticipate that investment activity in 4Q21 will again be led by reserve bank responses to the emerging trends in inflation, interest rates, and growth.
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Semiconductors make the world go around. Without it, you would not be able to read this article, drive to work tomorrow morning, or even heat your food in your microwave oven. Also known as integrated circuits, silicon chips, microchips, or simply chips, they are the brains behind every electronic component we use in our daily lives. Some chips like the central processing unit in your phone are highly complex and require sophisticated design and manufacturing capabilities to produce. Others, like the ones managing the on-and-off rhythms of our traffic lights, are fairly unsophisticated and can be produced at a relatively low cost.
If you have ever seen a movie like The Matrix, you will know that the language of computers is made up of zeros and ones. A single computer chip consists of billions of microscopic components called transistors. These transistors alternate between being in an “on” state or an “off” state, which a computer recognizes as either a “one” or a “zero”. These transistors allow chips to be programmed with a set of instructions which leads to all the wonderful things our electronics do for us.
When a technology firm designs and releases a new chip, they often state how many transistors they can fit onto the chip. The smaller the transistors, the more of them they can fit onto the chip and the more calculations the chip can perform at any given moment. Consider this example of Apple’s M1 chip which was released in 2020:
They proudly display the fact that their chip contains 16 billion transistors, and prominently mention that it was produced using a “5-nanometer process”. This is known as the process node and refers to the size of the transistors. The five nanometers node is the most advanced node humanity can currently produce, and there are only two companies in the world that can produce chips at this node (TSMC and Samsung). For the sake of reference, a five-nanometer transistor is smaller than bacteria and most viruses, and only slightly larger than a strand of DNA:
Source: Bloomberg Quicktake
An overview of the semiconductor industry
Today, most companies that design integrated circuits do not manufacture them. This was not always the case, but the industry has, over the last few decades, developed into what is commonly referred to as the “fabless-foundry” model. “Fabless” refers to the firms specialising in chip design without having fabrication capabilities, while “foundry” is a term for a semiconductor manufacturing facility. A few companies, notably Samsung and Intel, are capable of both designing and manufacturing semiconductors. These are known as integrated device manufacturers. Apple, AMD, Qualcomm, and Nvidia are some of the world’s leading fabless companies. The foundry market is dominated by Taiwan Semiconductor Manufacturing Company (TSMC). In fact, TSMC had captured more than half of the market by the third quarter of 2020, according to Bloomberg:
One of the reasons for this dominance is the cost, time, and expertise needed to manufacture semiconductors, especially at the more advanced nodes:
When the pandemic hit the global economy in early 2020, the world came to a near standstill and a chip shortage was one of the consequences. Despite making out a relatively small part of the chip end market, the auto sector was hit particularly hard and continues to suffer from chip shortages nearly two years after the start of the pandemic. Some of the reasons for the shortage in auto chips include the following:
• Automakers cancelled orders for electronic components during the early months of the pandemic as vehicle sales plummeted.
• Foundries responded by shifting their production lines to meet surging demand from consumer electronics as countries went into lockdowns and work-from-home became the norm.
• Aided by government stimulus and vaccinations, vehicle sales recovered faster than expected as the economic recovery gathered pace.
• Vehicle manufacturers ordered more chips than what they needed in anticipation of an imminent shortage, which exacerbated the shortage in a self-fulfilling prophecy.
General Motors Chief Executive Mary Barra estimated that the chip shortage could cost her company $2 billion in lost earnings. Ford, Stellantis (formerly Fiat Chrysler and PSA), and General Motors have borne the brunt of the auto chip shortage so far with over 800 000 vehicles in lost production for these three firms. In terms of when the chip shortage is expected to end, opinions vary widely. Wang Mei-Hua, Taiwan’s Minister of Economy, has voiced her expectation that the chip shortage could end as early as the fourth quarter of 2021. However, Daimler (parent company of Mercedes) Chairman Ola Källenius has said that they expect the shortage to last into 2023. Most experts place their predictions somewhere between these two dates. Only time will tell which prediction proves most accurate.
Geopolitics and semiconductors
Most of the world’s chips are produced in Taiwan. To say that Taiwan’s status is a politically sensitive topic would be a massive understatement. While most countries do not officially recognise Taiwan as an independent country, Western nations have expressed unofficial support for a free and democratic Taiwan. China, on the other hand, considers Taiwan to be a rogue province of China. In fact, Chinese President Xi Jinping has explicitly stated reunification with Taiwan as one of China’s strategic priorities.
The trade war between the United States and China has revealed the level of technological co-dependence between the world’s two largest economies. The United States has banned the export of certain critical technologies to China. Therefore, a Chinese takeover of Taiwan could lead to Taiwanese foundries being cut off from American and European technologies which are vital to the production of leading-edge semiconductors. The world is thus locked in a delicate balance with regard to semiconductor technology because everyone, including China, needs Taiwan and Western technology to manufacture leading-edge semiconductors. For its part, Western countries depend on Chinese infrastructure and labour to produce a large share of the world’s lagging-edge chips and consumer products.
The semiconductor crisis spurred governments around the world to become more self-sufficient in securing chip supply for their own industries. The response differs by country, but chip supply has become a matter of national security and a strategic priority for most nations. The Biden administration has sought to lure the likes of Samsung, TSMC, and home-grown Intel to invest in manufacturing capacity in the United States. The planned capital expenditure of these three firms in the United States is expected to exceed $45 billion dollars over the next three years. China has emphasised the acquisition of intellectual property and talent-related to leading-edge chip manufacturing in the next few years. Reports have emerged of Taiwanese engineers being poached by Chinese competitors in an effort to develop their own leading-edge capabilities.
As technology improves and the world becomes increasingly digital, we will become even more dependent on semiconductors to make our world go around. Preventing future shortages will require global coordination and the prioritisation of a secure supply chain by every country and company involved.