The Top Three Megatrends of 2025 and How to Invest in Them

Be Proactive, Not Reactive

• The rise of the Magnificent 7 may lead investors to believe they are well-positioned to benefit from thematic growth, but is that really true? In fact, the data tell us otherwise.
• Investors are too tethered to indices, leaving them underexposed to the leaders of once-in-a-generation economic transformations, such as the energy transition, supply chain reshoring and artificial intelligence.
• Active managers can drive the greatest returns from these rapidly developing megatrends by reacting quickly to new developments.

A Stock Picker’s Paradise

Through fundamental bottom-up research, our portfolio managers develop differentiated investment insights and select high-conviction stock ideas. We believe concentrated active portfolios minimize market risk and maximize opportunity for alpha generation.

The current macro landscape is creating an ideal stock-picking environment. Higher dispersion results in fundamentals-driven stock prices and peak market concentration levels pave the way for high-conviction active managers to identify overlooked outperformance opportunities.

 We believe the current market environment is advantageous for skilled, concentrated active managers that can navigate dynamics including the higher dispersion we expect going forward.

Three Themes We’re Excited About

1. Energy Transition: TCW Transform Systems ETF (PWRD)

The Energy Transition: The Next Industrial Revolution 

The energy transition—defined by the shift from traditional fossil fuels to cleaner alternatives in the quest for a lower carbon global economy—is the biggest economic transformation since the Industrial Revolution. Governments and companies across all sectors of the economy are investing historic levels of capital in solutions to transition from high-emitting “brown” solutions to more “green” alternatives. A record $1.8 trillion was spent on the energy transition in 2023, more than triple the amount just four years prior.¹ Despite this exponential growth, this level of investment remains insufficient. Achieving energy transition goals by 2030 will require $4-5 trillion each year—and sustained growth for decades to come thereafter.² 

^{Source: BloombergNEF. Note: start-years differ by sector. "Other" includes nuclear, energy storage, CCS, electrified heat, clean industry and clean shipping}

Transition is not just about Solar, Wind or Batteries 

Many energy transition strategies focus exclusively on scaling renewable power generation, such as solar or wind power. While these are increasingly viable sources of power and have become cheaper to produce, their intermittent nature doesn’t match the economy’s 24/7 power needs. To bridge this gap, considerable investment is needed in the existing fossil-fuel based infrastructure for transmitting and transforming energy to meet growing energy needs and drive decarbonization at scale. Delaying this investment means delaying the transition. “Greening” these “brown” industries presents an unprecedented investment opportunity that we expect to both deliver returns and contribute to a more resilient energy system.

Transforming our energy system involves a range of sectors that span the entire economy and present a diverse array of investment opportunities. These include obvious sectors like energy and utilities, but also include materials like cement and steel, industrials such as electrical equipment, machinery for construction and agriculture, and grid infrastructure components. Sectors like transportation and commercial services that support the build-out of new infrastructure are also likely to benefit.

Grid Investments are Long Overdue 

Recent U.S. policy has catalyzed the biggest investment in the electric grid in its history. The Inflation reduction Act and Bipartisan Infrastructure Law directed $29 billion in public funds to grid initiatives that are expected to stimulate $83 billion in grid investment through 2030.³ 

At the same time, the U.S. electric grid is facing an untenable situation in which aging and outdated infrastructure is meeting a dramatic acceleration in power demand. For the past two decades, domestic electricity consumption has remained largely flat. This created an environment of chronic underinvestment in the grid and power infrastructure in this country, rendering the U.S. grid unable to meet growing energy needs and increasing its vulnerability to extreme weather events. From 2015 to 2020, there was an average of 9,656 power outages annually, which is more than double the average of 4,609 for the previous six-year period.⁴Modernizing the grid is now a national imperative. It requires replacing obsolete transmission and distribution lines to reduce electricity losses in transit, as well as building new lines to accommodate additional sources of power. Through 2035, the U.S. needs to add 75,000 miles of high voltage transmission lines to the system—that’s enough to go from New York to Los Angeles and back about 15 times.⁵ 

An Increasingly Electrified Economy 

The structural forces of electrification and reshoring manufacturing were already driving an acceleration in electricity demand in the U.S. More recently, the surge in power demand from artificial intelligence data centers has only served as an incremental catalyst to that growth. These factors are the reason why the U.S. is experiencing its first increase in electricity demand in more than 15 years.⁶ The Energy Information Administration (EIA) forecasts that the US power sector will generate 3% more electricity in 2024 vs. 2023, and the Net-Zero America Project by Princeton forecasts that electricity demand could more than double by 2050. 

^{Source: New York Times. Link}

Total Electricity Demand Could More than Double by 2050 

^{Source: Net Zero America (Princeton), CSIS. Note, 100% Renewable Scenario involves nearly full electrification of transport and buildings by 2050, no fossil fuel use allowed by 2050, no land-use change for biomass supply allowed, no new nuclear power construction allowed, existing plants retired and no underground storage of CO2 allowed. High Electrification Scenario involves nearly full electrification of transport and buildings by 2050, no land-use change for biomass supply allowed and few other constraints on energy supply options.}

The extreme shift in the demand equation for electricity consumption in the U.S. is compelling enough on its own but becomes even more dramatic when considering how the supply side will meet this shift. Most electricity in the U.S. is still sourced from high-emission sources, which are reliable and 24/7 but detrimental to the environment. As more renewable power generation is brought online to meet a potentially doubling of electricity demand by 2050, we need to understand that we will need more than a doubling of capital investment. On average, 2-3MW of renewable capacity is needed to replace 1MW of fossil fuel capacity. That means a doubling of demand could lead to as much as a tripling of our grid infrastructure and a tailwind of capital investment that will create tremendous growth and investment opportunities. 

^{Source: Stout, Bernstein analytics}

With the profound shift in how the world’s energy and power are sourced, produced, transmitted, and consumed, we believe the transformation of our energy system will prove to be one of the defining investment themes of the coming decades. The transformation is just beginning, and we believe early investments in companies that are leading this transformation can drive alpha in the years ahead.  

¹  BloombergNEF. Energy Transition Investment Trends 2024. Link 
²  Barclays. The macroeconomics of the green transition. Link 
³  BloombergNEF, Grid Outlook 2023. Link 
⁴  Reuters. Link 
⁵  Utility Dive. Link 
⁶  New York Times. Link

Conclusion

Our concentrated active strategies aim to drive value for investors by identifying the companies most likely to win these long-term, cross-sector, economic transformations.

Looking forward, there remains considerable uncertainty with respect to the evolution of the U.S. economy. We think there is strong merit to focus on these secular themes that are not so dependent upon a strong macro backdrop to be compelling investment opportunities. We reiterate our unswerving focus on all-weather businesses that exhibit proven management skill, pricing power, low levels of indebtedness, strong free cash flow generation and a likely resilience in the face of a pronounced economic slowdown.

2. Supply Chain Reshoring: TCW Transform Supply Chain ETF (SUPP)

A Tidal Shift: From De-industrialization To Re-industrialization

Global supply chains are undergoing a massive transformation. It is rare to go a day without hearing mention of at least one of the following phrases: reshoring, nearshoring, regionalization or a multi-polar world. For the 75 years prior to 2020, global supply chains prioritized the lowest possible direct manufacturing costs, shifting production to low-cost regions abroad. This outsourcing coincided with an economic transformation that led to a loss of about seven million U.S. manufacturing jobs from 1980 to 2020, or about one third of the 1980 manufacturing labor force.⁷ 

More recently, parallel forces across policy, economics, geopolitics, and public health and natural disasters are driving major global supply chain disruptions and accelerating the reshoring trend. Notably, the COVID-19 pandemic exposed the fragility of supply chains. Companies and governments have since begun to re-evaluate the flow and sourcing of key goods, raw materials, manufacturing and distribution networks. While this phenomenon is global, U.S. policymakers have been shaping policy to reshore and rebuild domestic manufacturing capabilities in industries that are critical to the U.S. economy. As a result, the U.S. has significantly increased spending on building factories, infrastructure and other key economic drivers of manufacturing since 2021. 

^{Source: Federal Reserve Bank of St. Louis, inflation adjusted}

“Just-In Time” Just Doesn’t Work

One of the biggest challenges is that the longstanding and sprawling global supply chains often relied on single-sourcing and “just-in-time” inventories. The auto industry is an example where supply chain disruptions impacted consumers in an unprecedented way. Consumers saw auto prices soar during the pandemic, caused by a chip manufacturing slowdown in South Korea and Taiwan that limited critical supply for modern cars. But this is just one of many examples of shortages that extended across the U.S. economy from consumer goods, raw materials, building supplies and other industrial inputs that were essential for business operations. 

Since COVID upended the world economy, references to onshoring in company earnings presentations have increased 10-fold.⁸While we do not anticipate a full-scale retreat to economic isolationism, we have only just begun to see increased supply chain diversification and the unwind of a reliance on China as the low cost-producer to the world. The need to diversify and regionalize production in order to bring goods and reduce reliance on single-sourcing will drive tremendous shifts in value, creating investment opportunities not seen in decades.  

Enhancing U.S. Economic Competitiveness Requires Increased Domestic Manufacturing

The traditional rationale for industrial policy—to maintain and improve global economic competitiveness—remains a key objective for rebuilding U.S. domestic capacity in strategically important industries. U.S. policies, such as the Infrastructure Investment and Jobs Act, also known as the Bipartisan Infrastructure Law (BIL), direct more than $1 trillion in federal funds to improving the nation’s infrastructure including transit, energy, broadband, water and sewage systems.⁹ This law requires that all of the iron, steel, manufactured products and construction materials used in federally-funded infrastructure projects are produced in the United States. To date, $480 billion in BIL funding has been announced across 60,000 projects.¹⁰ With the current project pipeline and remaining funding to be allocated, significant growth lies ahead for U.S. industrials, materials and commercial services companies. 

Restoring U.S. manufacturing and diversifying supply chains reduces risk related to supply shocks and trade disruptions that cause bottlenecks to building key technologies and infrastructure. Though the U.S. invented the semiconductor, today it produces only about 10% of global supply. Semiconductors serve as key inputs into the advancement of medical devices, communication technologies, energy infrastructure, aerospace and defense products. They also are fundamental to emerging technologies, such as artificial intelligence and quantum computing. Two years since the CHIPS and Science Act passed into law, companies have announced nearly $400 billion in domestic semiconductor investments. This momentum is set to position the U.S. to control 30% market share of the most advanced chips by 2032.¹¹ 

^{Council of Economic Advisers Source: U.S. Census Bureau of Labor Statistics, CEA Calculations. Note: Deflated using the PPI Final Demand Construction for Private Capital Investment (post-2009) Gray bars indicate recessions. As of November 8, 2023, at 2:47 p.m.}

In our view, there is an enormous investment opportunity in the companies leading and enabling this historic supply chain transformation.

⁷  Bureau of Labor Statistics, accessed through FRED. Link 
⁸  IMF. Link 
⁹  U.S. Treasury. Link 
¹⁰  White House. 
¹¹  White House. 

Conclusion

Our concentrated active strategies aim to drive value for investors by identifying the companies most likely to win these long-term, cross-sector, economic transformations.

Looking forward, there remains considerable uncertainty with respect to the evolution of the U.S. economy. We think there is strong merit to focus on these secular themes that are not so dependent upon a strong macro backdrop to be compelling investment opportunities. We reiterate our unswerving focus on all-weather businesses that exhibit proven management skill, pricing power, low levels of indebtedness, strong free cash flow generation and a likely resilience in the face of a pronounced economic slowdown.

3. Artificial Intelligence: TCW Artificial Intelligence ETF (AIFD)

The AI Infrastructure Buildout Is Just Getting Started  

Artificial intelligence (AI) has been around, in some form, for decades. The relentless innovation in semiconductor design brought compute, memory and networking to a critical tipping point. This allowed for the deployment of larger, more capable models at the same time the amount of publicly available trainable data allowed for higher-quality results. Out of this confluence of events came the commercial release of ChatGPT in late 2022 and the dawn of the generative AI era.  

Less than two years into what we believe will be a decades-long megatrend in technology, we believe we are still in the very early innings of the investment opportunity. Companies are investing heavily in the data center infrastructure necessary to support AI services, to drive internal growth and to avoid being left behind. The hyperscale cloud service providers (CSPs) are spending hundreds of billions of dollars¹²collectively in an effort (unsuccessfully, so far) to keep up with demand, with estimates still rising. We believe the investment required to build these capabilities is here to stay, because companies view AI as a strategic, even existential, priority. 

^{Source: TCW, Bloomberg. This excludes Amazon as their retail business distorts their investment in datacenters. Future estimates come from Bloomberg consensus as of 8/1/2024}

Demand continues to outpace supply for AI-related infrastructure, and the gap is likely to expand as models and training requirements get exponentially larger. The supply/demand imbalance ranges from chips to cooling systems. Microsoft indicated on a recent earnings call that AI supply will remain below well into 2025, at least¹³—despite spending $50B+ on capex this year and growing.¹⁴

We see enterprise spending picking up in the near- to medium-term as companies use smaller, customized, more affordable models to perform specific tasks. As AI spreads out into all sectors of the economy, the potential incremental spending from enterprises could be roughly in line with the investments being made by the CSPs. This is another leg of growth still to come.  

It Is Not Too Late To Invest In AI

While AI stocks led the market higher in the first half of 2024, the run is very similar to prior technology megatrends. For example, over a five-year period in the smartphone cycle, a basket of "smartphone winners" returned ~365% with a peak return of nearly 440%. Prior tech waves (smartphone, PC, cloud) created five-to-10-year investment opportunities with multi-triple-digit returns—and some are still playing out. Even after the initial gains, we are still in the very early innings of the AI wave.  

^{Source: TCW via FactSet data. AI Winners Basket = AAPL, AMZN, GOOGL, META, MSFT, NVDA, ORCL, TSLA (12/31/22 = 100); Smartphone Winners Basket = AAPL, AVGO, CRUS, QCOM, QRVO, SWKS, SYNA, TXN (12/31/08 = 100); PC Winners Basket = AMD, ADI, AVT, HPQ, IBM, Tandy Corp, Commodore Comp, INTC (12/31/79 = 100); Cloud Winners Basket = AMZN, MSFT, CRM, WDAY, NOW, MDB, SAP (12/31/16 = 100); Baskets are equal-weighted composites of indexed security prices.}

Use Cases Touch All Sectors Of The Economy

We also see artificial intelligence as a multi-decade trend given the potential applications across industries and the relatively low adoption rate. Companies will also need to create AI-powered products that resonate with a large audience. A few examples include:  

• Software engineering: AI has been shown to increase the productivity of software engineers by a factor of two,¹⁵potentially helping to address the shortage of available programmers. AI copilots also increase upward mobility of employees by giving them new skills.
• Creative industries: The largest opportunity might lie in augmenting the creative process with first drafts and automating tedious tasks, but generative AI could also take on the roles of copy writing, graphic design and brand management (under human supervision).
• Autonomous vehicles: Waymo and Tesla are closing in on fully autonomous vehicles that are based on neural networks. These systems can learn how to drive and how to react to new and unique situations, rather than following a set of prescribed rules.  
• Healthcare: The U.S. alone spends $4.5 trillion per year on healthcare.¹⁶ One-third of that is estimated to be related to administrative tasks well-suited for AI. Taking one-third of that cost out would yield an annual savings of $500 billion,¹⁷free up more time for doctors to spend with patients, alleviate bottlenecks to receiving care and ultimately save lives. AI-powered diagnostic imaging, drug design and virtual clinical trials promise to save even more lives.  

These use cases are all possible today but aren’t widely being used, which is why we believe we are still in the early innings of the AI megatrend.

¹² TCW research via Bloomberg data
¹³ Microsoft. Link
¹⁴ Microsoft Financial Statements. Link
¹⁵ GitHub Blog. Link
¹⁶ CMS Medicare. Link
¹⁷ TCW Research

Conclusion

Our concentrated active strategies aim to drive value for investors by identifying the companies most likely to win these long-term, cross-sector, economic transformations.

Looking forward, there remains considerable uncertainty with respect to the evolution of the U.S. economy. We think there is strong merit to focus on these secular themes that are not so dependent upon a strong macro backdrop to be compelling investment opportunities. We reiterate our unswerving focus on all-weather businesses that exhibit proven management skill, pricing power, low levels of indebtedness, strong free cash flow generation, and a likely resilience in the face of a pronounced economic slowdown.

DISCLOSURES

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Effective October 13, 2023, TCW acquired the Transform ETF business from Engine No. 1 and the Transform Funds' adviser became TCW Investment Management Company LLC. Prior to that date, the Transform Funds' adviser was Fund Management at Engine No. 1 LLC.

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