Talking heads – Ein Silberstreif am Horizont für grüne Aktien

This is an edited transcript of the audio recording of this Talking heads podcast

Daniel Morris: Hello and welcome to the BNP Paribas Asset Management Talking heads podcast. Every week, Talking heads will bring you in-depth insights and analysis through the lens of sustainability on the topics that really matter to investors. In this episode, we’ll be discussing the upcoming wave of green investment. I’m Daniel Morris, chief market strategist, and I’m joined by Ed Lees, co-head of our Environmental Strategies Group. Welcome, Ed, good to have you back.

Edward Lees: Hi, Daniel. Great to see you again.

DM: It has been a challenging couple of weeks. We’ve had volatility in the markets. Interest rates have gone up by quite a bit in a relatively short period. Almost everyone expected that that would cause turmoil somewhere, somehow. If there is any surprise, it’s that it is in the banking system. We had thought that all of that had been fixed post the global financial crisis and new regulation. Evidently, that wasn’t the case. Nonetheless, if we look at how markets are reacting, what has been notable has been the outperformance of growth stocks, reversing at least some of last year’s underperformance as policy rate expectations rose. If we look at the investment universe and investment landscape that you deal with, what has been the impact of the turmoil in the markets?

EL: It certainly is not fun to see a crisis again in the banking sector just because it’s so central to everything we do. This kicked off with Silicon Valley Bank. As soon as that happened, we went out to our companies, particularly those based in California – just to ask did they have any cash at the bank? Did they have any open lines of credit at the bank? Thankfully, the answer was very little. We had one company with about 2% of their cash at the bank. Another quoted a low single digit percentage. One had a very small portion of a larger credit facility with multiple banks there. That has all been backstopped now anyway. The bigger issue is the tightening of the broad lending standards that’s going to come, particularly at regional banks, and what that’s going to mean for accessing capital. It has spilled over and we’re still working through that. Where does this leave us? Clearly, the start-up tech scene, venture capital and private equity companies are going to be more impacted in the immediate term. When we look at our names, one of the sectors that was hit the hardest was the residential solar market because they have to raise a lot of money and will typically do that through asset-backed securities. Our checks indicate this area is operating fine for solar companies. Their credit position is really good. Their customers don’t want to default because then they would have to pay higher rates. So, the knock-on impact is that the banking issue does make it harder for the Federal Reserve to raise interest rates.

We now have a market that has quickly swung around to discount multiple rate cuts by year-end. There’s still some friction between those market expectations and what the Fed is saying. But we expect rates will have to come down and lower rates should help longer-duration growth assets and those companies that need financing. Lower rates also influence the market multiple of stocks, with lower rates helping to support a higher multiple. That is relevant as we try to figure out if the market is already sufficiently pricing in a recession. The recent steepening of the yield curve could indicate that a recession is about to start. The question is how far earnings will ultimately fall. There is historical evidence that equities that have suffered due to rising rates and inflation should recover when rates and inflation peak. There are reasons to believe that we’re close to that point. Furthermore, if you look at inflation outbreaks from the 1940s through the 1980s, they tended to recede at a pace that is similar to their rise, arguing against a prolonged topping here. From an outlook perspective, I see more deflation coming. We have some evidence of that. China’s industrial profits came in at almost -23% versus -1.5% expected and -4% in January. This should influence the CPI in China, which tends to lead the US CPI. We have other indicators that are showing inflation starting to come down. If that persists and rates do come down like the market is expecting, we could continue to see a recovery in growth stocks.

DM: So let’s dive into the detail, particularly on the policy front, starting with the US Inflation Reduction Act. That’s been followed up by an EU version. California is also looking to incentivise more investment in green programmes. Can you talk about those developments and where the opportunities might be?

EL: Let’s start with the Inflation Reduction Act. This is the year of enactment. Many in the market have been waiting for clarity from the Treasury regarding the implementation of the act. We expect that we’ll get more clarity between now and the summer. For example, Treasury EV guidance, which we expect by the end of March. This will provide certainty for carmakers as they evaluate their supply chains. We might also get some light duty vehicle information regarding emissions from the EPA. On battery manufacturing and sourcing guidance, that’s one of the key areas of focus. This will be interesting, for example for Ford’s partnership with CATL. We should hear about the clean vehicle credit that’s known as 3D. Will we get a widening of a free trade agreement with flexibility to add new agreements? What percentage will there be on critical mineral extraction and processing requirements? We’ve already seen a widening of the definition of what qualifies as an SUV under the credit. We’ll also get some news on commercial clean vehicle credits. There’s been more flexibility in the past.

EVs produced in Europe and Asia are still likely to be eligible for this credit. There may be some information on previously owned clean vehicle credits. Broader Treasury Department rulings with more details on solar, wind and hydrogen will be expected by the summer. This is all coming up fairly soon. This is really important because there’s been a lot of excitement over the US Inflation Reduction Act, with over USD 40 billion of new capital committed to 13 gigawatts of new green energy projects and 20 manufacturing facilities just by last December. This is now being followed with thousands of comments submitted to US Treasury and the IRS requesting clarification on how investors can be certain of qualifying for the act’s new and extended tax credits, grants and programmes. The key job ahead is implementing the laws that were passed. As a reminder, the Inflation Reduction Act, when implemented, could improve projected US emission reductions through 2030 by 10% and increase clean energy’s estimated 40% share of US electricity generation in 2021 to as high as 80% in 2030. This is a transformational event that will benefit our sectors.

DM: We’ve seen that Europe feels it can’t stand by idly and let European companies go to the US and  invest there. They’re trying to modify incentives here. What’s been going on on the European front?

EL: Europe needs to respond to ensure that Europe’s energy security remains intact by strengthening its domestic supply chains. It’s doubly important in Europe, not just because of the climate, but also because of the situation with Russia and Ukraine. There’s been some doubt about how effective this policy support could be, given how bureaucratic things can be. But it looks like it’s actually coming together in some cases where there’s a risk of resources being moved from Europe. There appears even to be scope for full matching with the US Inflation Reduction Act as well as potential for local incentives. We’re going to have to monitor this. On 16 March, we had some details: Europe is targeting 40% clean energy equipment being sourced locally for solar. This is a six-times increase for local content. Now we expect member states to submit updated draft climate plans by June. All of this is to give some clarity around the EU Commission’s industrial plan, which comprises of the Green Deal, the Net Zero Industry Act, the Critical Raw Materials Act and reform of the electricity market’s design. The Council has approved this plan, but it’s now subject to approval from the EU Parliament. The Commission should start to work on implementation in the coming months if that approval comes through, as we’d expect. In summary, it’s pretty exciting and it’s been a fairly efficient process so far that’s moving faster than I had originally thought. Between the EU action, the US Inflation Reduction Act and the potential for peaking rates, we see a constructive setup for our space over the remainder of 2023.

DM: My thanks to Ed for sharing his insights.

EL: Thank you, Daniel.

Disclaimer

Please note that articles may contain technical language. For this reason, they may not be suitable for readers without professional investment experience. Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. This document does not constitute investment advice. The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns. Investing in emerging markets or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions). Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.

Environmental, social and governance (ESG) investment risk: The lack of common or harmonised definitions and labels integrating ESG and sustainability criteria at an EU level may result in different approaches by managers when setting ESG objectives. This also means that it may be difficult to compare strategies integrating ESG and sustainability criteria to the extent that the selection and weightings applied to select investments may be based on metrics that may share the same name but have different underlying meanings. In evaluating a security based on the ESG and sustainability criteria, the Investment Manager may also use data sources provided by external ESG research providers. Given the evolving nature of ESG, these data sources may for the time being be incomplete, inaccurate or unavailable. Applying responsible business conduct standards in the investment process may lead to the exclusion of securities of certain issuers. Consequently, fund performance may at times be better or worse than the performance of relatable funds that do not apply such standards.