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Opinion

It’s Time To Make Your Portfolio Greener

Peter Garnry
It’s Time To Make Your Portfolio GreenerImage by PIRO4D from Pixabay, Pixabay License

The fire that engulfed Australia had alarm bells ringing in every country in the world. With millennials demanding action on climate change, there is a sense of a new period starting with great opportunities in equities.

It is apparent that political capital is being mobilized to improve the environment. Governments are increasing investments and subsidies for “green” industries, starting a new megatrend in equity markets. These green stocks could, over time, become some of the world’s most valuable companies—even eclipsing the current technology monopolies as regulation accelerates during the coming decade. Now is the time for investors to consider tilting their portfolios towards green stocks so they don’t miss this long-term opportunity.

Several industries will drive a less carbon-intensive future, the most obvious of which are solar, wind, fuel cells, electric vehicles, hydro, nuclear, bioplastic, recycling, water, building materials, and food. Some of these industries are mature and experiencing a renaissance while others are emerging technologies that come with high risk.

The risk factors impacting the different industries are both systemic and idiosyncratic. From a risk perspective, relative to the general equity market the hydro, nuclear, recycling and water industries are less risky as their demand profiles are more stable than the overall business cycle. Solar, wind, electric vehicles and building materials are more cyclical than the general market and would be impacted more negatively during a recession.

The fuel cell, bioplastic and food (in this case plant-based) industries have far more idiosyncratic risks as they are more nascent than the other industries. The fuel cell industry is heavily dependent on government subsidies as the industry rolls down the technology curve in terms of the cost of production, so the industry is very high risk. The bioplastic industry is a small and fragmented, and publicly-listed bioplastic companies could easily lose out to larger names in the traditional chemical industry.

Except for nuclear and wind turbines, all of the industries trade at a valuation premium to the global equity market. This premium reflects investors’ optimism about future cash flows in those industries. Higher expectations do, however, predict a higher risk if these expectations are not met.

Another important point about these companies is that they are operating in the physical world. Unlike, say, the software industry, where the return on capital is insanely high and scales easily. These greener industries all require vast amounts of capital to operate — and as such, the low-interest-rate environment has helped fund growth. If interest rates rise again, this is predicted to negatively affect their operating conditions and equity valuations.

Central banks and governments have decided to throw out the old playbook of not adding stimulus in the late stage of an expansion in which the labor market is tight. Both monetary and fiscal policy is readily being deployed in 2020 across all the world’s largest economies. This is not the time to be underweight equities. With the OECD’s leading indicators moving from contraction to recovery back in October, the historical backdrop tells us that the best period for equities against bonds is ahead.

During the recovery phase, emerging market equities tend to outperform developed market equities by a wide margin. European equities typically outperform the market during the late expansion and early slowdown. This time investors are advised to overweight European equities. A weaker quarter-four USD, which the world needs, has historically led US equities to underperform against European and emerging-market equities.

Global recession probability peaked back in September, and with stimulus flowing through the economic pipes the recession has most likely been averted this time. The other risk that could, however, derail equities in 2020 is inflation, which seems to be picking up again. Equities tend to respond positively to short-term inflation shocks but negatively to sustained inflation rate above 3%. Higher inflation rates and inflation shocks have historically led to more equity volatility. In 2020, investors should watch inflation closely.

Image by PIRO4D from Pixabay, Pixabay License

Head of Equity Strategy at Saxo Bank

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