Less than four months ago, the world was digesting the results of the COP26 Climate Conference, with widespread commentary that we were both heading for a more sustainable economy and at the dawn of a new industrial revolution based on clean technologies. Yet since the start of 2022, equity markets have fallen amid concerns about inflation, the end of quantitative easing, and rising interest rates.
Russia’s invasion of Ukraine has rattled global market sentiment, with investors worried about the wider implications of the conflict. The share prices of companies at the vanguard of the sustainable economy have suffered more than most – for example, the FTSE Environmental Opportunities All-Share Index dropped 11% between 1 January and 28 February 2022, while the MSCI ACWI Index fell by only 8%.(1) What’s going on?
It’s no surprise that rising generic risk indicators have triggered a rotation away from “growth” to “value” oriented stocks and sectors, as weaker consumer sentiment and spending power are expected to impact corporate earnings, particularly in discretionary areas. And with political instability on Europe’s eastern borders and the possibility of severe disruption to natural gas markets, it is likely that many investment decisions will be delayed.
But what’s the read across to the sustainable economy? For investors taking a medium-term or longer perspective, there seems little reason to discount the statements made by governments, major corporates and financial institutions that investment in renewable power generation, zero-emissions transportation and resource efficiency will continue to grow, taking market share from legacy sectors. For example, G7 countries and the EU have committed to largely decarbonise their electricity sectors during the 2030s,(2) while policy commitments to ban the sale of passenger vehicles with internal combustion engines (ICEs) have prompted several high-profile vehicle manufacturers, including Ford and General Motors, to sunset the manufacturing of ICE vehicles worldwide. (3)
The crisis in Ukraine is likely to strengthen further these drivers. Once the political situation stabilises, European governments in particular will surely seek to reduce urgently their dependence on Russian gas, which accounts for 38% of EU gas imports and provides the majority of the energy used for heat in several countries. As for Russia itself, it is clear that the world’s largest gas exporter and second-largest oil exporter needs to secure its future prosperity as fossil fuel demand wanes. (4) A vision for a prosperous, low-carbon Russia must be developed to help ensure a peaceful transition.
Among gas importers, we can expect heightened concerns about energy dependency to combine with additional doubts about the resilience of longer supply chains, as illustrated by the six-day blockage in 2021 of the Suez Canal, to drive further calls for accelerated investment in domestic renewable energy generation.
With a longer-term perspective, it’s likely that initiatives to launch a global hydrogen economy will also be fast-tracked, providing an attractive solution for the challenges of decarbonising heat as well as some transportation fuels, for example in the marine sector. Today, almost all the hydrogen we consume is sourced from natural gas; however, the rapid drop in the cost of electrolysis is making zero-carbon (or “green”) hydrogen a commercial reality, and public-private partnerships to establish industrial clusters using hydrogen-based energy offer a route to establishing scale in this nascent sector. Watch out for an up-tick in the pace of announcements in this area!
Outside the energy sector, we’re still expecting that resource efficiency, climate resilience and ecosystem protection will become major themes guiding capital expenditure. For example, the first part of the US post-COVID stimulus plan includes US$213 billion to make buildings and homes more energy efficient, while 30% of the €750 billion EU Recovery Plan will target initiatives to address climate change.(5) In parallel, the emergence of mandatory “sustainable finance” disclosure requirements on fund managers plus the adoption by governments of green taxonomies is likely to raise the attractiveness of investments that are consistent with a more sustainable economy, thereby reducing the cost of capital for eligible companies.
Experience from previous periods of market volatility reminds us that trying to “catch the falling knife” by rushing into the market is usually unwise. However, after more than half a decade of relative market calm and often eye-watering valuations, investors with capital to deploy may look back on the early part of this year as a great buying opportunity. It’s too early to conclude that we’ve reached the apocryphal point of “capitulation”, when almost all the investors minded to throw in the towel have done so. However, when that time comes, those companies whose business plans are resonant with a more sustainable economy, with low leverage and pricing power, should offer compelling opportunities.
(1) FTSE Russell, MSCI. Index returns in US dollars.
(2) Statement by the G7 Presidency of the UK Net-Zero Power: Commitment to Action, 20 October 2021
(3) COP26 declaration on accelerating the transition to 100% zero emission cars and vans, 10 November 2021
(4) IEA, February 2022
(5) White House, European Commission
The article is written by IMPAX Asset Management one of the managers within the Irongate portfolios
The value of an investment can go down as well as up.
You may get back less than you invested.
Past performance is not a reliable guide to future performance.
The opinions expressed are those of Irongate, this material is not a recommendation, or intended to be relied upon as a forecast.