Capital Markets in Turmoil: Navigating Uncertainty and Preserving Long-Term Growth

　　Global Economic Uncertainty: A Complex Landscape

　　The COVID pandemic has sent shockwaves through global capital markets, creating a state of turbulence that persists as countries navigate recovery. Compounding this uncertainty are the ongoing war in Ukraine, escalating inflation, rising interest rates, banking sector instability, and the looming threat of climate change. These multi-dimensional challenges have led to increased discount rates, posing a significant risk to companies whose valuations depend on long-term growth potential.

　　Assessing Vitality: Measuring Long-Term Growth Potential

　　Amidst this uncertainty, calibrating and interpreting recent events becomes crucial. Are we witnessing a shift towards short-term results at the expense of long-term growth? Will the tech sector, a traditional growth engine, face stagnation? To gain perspective, we analyze shifting patterns in "vitality" - a measure of firms' long-term growth potential. For the past five years, BCG and Fortune have collaborated on the Future 50 index, identifying the world's most vital companies. This index is based on a predictive model that quantifies a company's long-term prospects using financial and non-financial indicators, such as strategic orientation, technology investments, patent portfolio quality, leadership diversity, and recent sales growth.

　　Key Trends in Vitality: A Historical Perspective

　　Our analysis reveals that any company, regardless of industry or geography, can achieve high vitality. However, historically, the most vital companies have been tech-focused, concentrated in IT and communication services or utilizing digital technology disruptively in other sectors. The growing importance of sustainability as a business model opportunity is reflected in the increasing presence of green tech and renewable energy firms in the index. Notably, the COVID pandemic also propelled several healthcare players to achieve high vitality in 2020 and 2021.

　　Geographically, the United States has dominated the index, with China occupying a strong second place. However, the rest of the world has had a relatively limited presence in the upper ranks.

　　Industry View: Tech Remains the Dominant Source of Growth

　　Consistent with previous years, tech-focused companies, particularly from the IT and communication services sectors, continue to dominate vitality scores. This trend persists despite significant market revaluations in 2022 and ongoing layoffs in the sector. However, closer examination reveals that tech giants have made substantial net additions to their workforce over the past two years. The recent dismissals can be interpreted as short-term corrections due to heightened investor pressure on profitability rather than indicators of diminished growth potential.

　　Our analysis suggests that the long-term outlook for sectors such as business or consumer software and services, as well as semiconductors, remains positive. Many of the most vital tech players operate in these segments.

　　Business Software: Adapting to Challenging Times

　　In the face of potential recession and higher capital costs, many businesses have delayed or reduced investments in IT or cloud services. Despite this, the digital transformation of the workplace is likely to continue. Companies providing tools that streamline operations, enhance efficiency, bolster cybersecurity, or unlock new sources of value (e.g., marketing tech) still have room for growth.

　　Some highly vital companies are succeeding in these challenging times by reducing exploration costs - finding cheaper ways to build potential future sources of advantage. This is particularly crucial in times of constrained or expensive resources, such as labor and capital. Firms can achieve this by paying closer attention to their customers' execution and search processes, extracting valuable information that informs their own exploration. For example, Datadog, a provider of monitoring and analytics tools in the cloud, ranked #3 on the 2021 Future 50 index, accepts user contributions to its software through an open-source model. This strategy reduces exploration costs and makes the firm more attractive to customers, especially as many firms consolidate cloud spendings with fewer providers.

　　Consumer Software: Entertainment and Marketing

　　Consumers continue to turn to digital devices for entertainment, a trend that has stabilized at a high level as the world emerges from COVID lockdowns. While growth is cooling off in some core sectors, such as streaming, our analysis suggests that players providing technology or services solutions for marketing, delivering, and monetizing entertainment continue to be well-positioned for growth. An example is The Trade Desk, #27 on the 2021 index, which specializes in digital marketing automation and personalization. The company has outpaced its peers and gained significant market share in a challenging environment.

　　Semiconductors: Facing Challenges, but Still Promising

　　The semiconductor industry faced difficulties in 2022 due to slowing demand for consumer electronics and trade restrictions, particularly the US export controls on advanced chip manufacturing equipment to China. However, the long-term demand for computing power, data storage, electric cars, and industrial applications (e.g., automation) suggests that there is still ample room for growth for companies like Nvidia, #49 on the 2021 Future 50. However, it remains to be seen how much of this growth producers in different geographies will be able to capture.

　　The Rise of Climate Tech Continues

　　Continuing a recent trend, climate tech companies, such as those developing components for solar panels and batteries, score highly on vitality. This segment will continue to grow as the effects of climate change and changing societal perceptions compel governments and firms worldwide to transition towards more sustainable energy sources and systems.

　　Green tech is not exclusive to young, purpose-built companies. Incumbents can also reposition for growth. For example, Chinese firm Tongwei Co started as a fish feed supplier in 1995 but leveraged its established connections to fish farmers to enter the sustainable energy field. Tongwei expanded into the development and production of photovoltaic modules, creating solar fishery projects that provide shade to fish ponds, increasing seafood yield. The company has become the world's largest supplier of polysilicon, a key solar material, in the process.

　　Healthcare Players Coming Back to Earth

　　The healthcare sector experienced accelerated growth during the pandemic, with some players, particularly from the biotechnology field, topping the vitality charts. However, the boost provided by the pandemic has receded, and analysts expect the long-term prospects for this sector to be strong.

　　Old-Economy Companies Continue to Lag Behind

　　In aggregate, sectors like financials, utilities, real estate, and consumer staples continue to lag in terms of vitality. These sectors face tangible limits to growth due to encroaching constraints on natural resources, labor, and capital, as well as a less obvious scope for innovation. However, some firms buck the trend by viewing constraints as opportunities for differentiation and growth. One option is to expand into the digital realm to find innovative, less resource-intensive paths to growth. For example, fitness apparel company Lululemon athletica (#30 of the 2021 Future 50) acquired Mirror, a tech start-up selling fitness mirrors for working out at home, in 2020, expanding into digital fitness subscription services. Lululemon is using the service to build a community of fitness enthusiasts, which will also help the success of its core business.

　　Geography Lens on Vitality: The U.S. Extended Its Lead

　　The historical dominance of the U.S. in our vitality rankings can be attributed to structural advantages, such as a mature venture capital industry, strong entrepreneurial activity, and a well-established technology industry. In 2022, this position was further bolstered by the relative strength of the U.S. economy, which has seen a faster recovery from the COVID-induced crisis than others.

　　China's Vitality Waned Somewhat - But It Remains in Second Place

　　The Chinese economy faced pressure in 2022 due to COVID lockdowns, persistent outbreaks, a troubled real estate market, and geopolitical tensions. Despite these challenges, more than half of the Chinese companies that continue to score highly on vitality hail from the green technology sector. China has ambitious goals to produce 33% of its energy with renewable sources by 2030 and has invested heavily in developing and capturing the market domestically and globally. Other vital Chinese players are mostly concentrated in the tech space.

　　Europe Continues to Struggle on Vitality

　　Europe continues to lag in terms of vitality, driven by lack of VC funding and market fragmentation, with few global champion technology enterprises. The outbreak of war on the continent and surging energy prices amplified these effects in 2022.

　　Diversity Matters, but Progress Is Still Slow

　　Past analyses have shown that companies scoring highly on vitality tend to be more diverse in terms of gender, likely due to a resulting greater capacity for innovation and reinvention, key to achieving growth. This continues to be the case, with the most vital companies having higher shares of female executives and managers than other players. However, there is still a long way to go to achieve gender parity, and progress on this front remains slow - for the market overall and even for the most vital companies.

　　Overall Continuity - But With New Trends Emerging

　　Empirical evidence shows that long-term returns are predominantly driven by differential growth, particularly in volatile times. Companies and investors should be careful of sacrificing long-term growth potential for short-term returns even at an elevated cost of capital. Our analysis helps make sense of trends in vitality - showing that, while the world has experienced much short-term turbulence, there is much continuity in these trends. Moreover, while the environment is the most difficult it has been for growth-oriented companies in at least two decades, we show that companies can succeed in remaining vital. Some of the keys to success are enhancing efficiency in the search for new growth options (e.g., Datadog) and looking for growth opportunities outside of one's traditional core business - ideally linked to sustainable or less resource-intensive approaches (e.g., Tongwei, Lululemon).

　　Even as we write this report, new trends are emerging that may change the picture again. For one, the recent fall of SVB added financial instability to the macroeconomic landscape, making recession or even structural break more probable. The other elephant in the room is artificial intelligence, which appears poised to disrupt industries and workflows. For a comprehensive view on how these trends will affect long-term growth prospects, watch this space for our full update on the state of vitality, including the Future 50 index, in December 2023.

　　Martin Reeves is a managing director and senior partner at BCG and chairman of the BCG Henderson Institute. Magdalena Krupa is a lead data scientist at BCG X and an ambassador to the BCG Henderson institute. Adam Job is a director at the BCG Henderson Institute.

　　Subscribe to Well Adjusted, our newsletter full of simple strategies to work smarter and live better, from the Fortune Well team. Sign up today.