Quarterly Commentary 3Q’22
Markets waffled through the 3rd quarter of 2022, grappling with uncertainty around the economy and global events. But the quarter also brought two key announcements that we see as providing clear and perhaps pivotal direction for the economy, the markets, and the global energy transition.
From 0 to 3 percent in 188 days
First, the US Federal Reserve made clear that its top priority is fighting inflation – even if that means pushing the economy into recession. The Fed went on to announce two back-to-back 75 basis point (0.75%) increases in the federal funds rate during the quarter which, when combined with earlier rate moves, had the net effect raising rates by a steep 3 percentage points over a short 6 months. The Fed signaled that as long as inflation is elevated, rates are likely to keep rising – so there’s likely more to come.
The US Fed is not alone; central banks around the world are raising rates to quell inflation and there are ripple effects. The UK in particular is struggling to fend off financial crisis spurred by interest rate exposures in their pension fund investments. In addition, the strength of the US dollar relative to other currencies is putting additional strain on other economies, impacting trade, and weighing more heavily on stock prices outside the U.S. While there are some early signs of slowing in the housing markets and in corporate earnings projections, we have yet to see a clear peak in inflation. Conversely, consumer spending remains strong and unemployment is near all-time lows. We may very well may be headed for recession – but we are not there yet.
The rising rate environment is bearish for both stocks and bonds, and that continued to be reflected through the 3rd Quarter. With new clarity on inflation and rising rates, markets that had started the quarter strong took a downward turn in September that erased earlier gains for most major benchmarks. For the full 3rd Quarter, the global MSCI All Country World Index returned -6.7% and the US-based S&P 500 -4.9%. Bonds also suffered, with the benchmark Bloomberg Barclays Aggregate Bond Index-4.8% for the quarter. For the year-to-date, broad market benchmarks are all now in correction territory, with the MSCI ACWI and S&P 500 down roughly 25% and broad bond indexes down near 15%.
In this rising rate environment, we’re staying focused on investments that have weathered previous inflationary environments with relative strength: high-quality stocks of companies with strong balance sheets, sustainable earnings, and promising innovations. In bond portfolios, we’re staying conservatively positioned with high credit quality and shorter average duration, with exposure across maturities to take advantage of the changing interest rate environment.
Turning It Up To 11: The New Climate Bill
The other clarifying event came in August when the US Congress (surprisingly!) signed into law a monumental new climate bill. The Inflation Reduction Act – we’re going to call it simply the “Climate Bill” instead – catapults US climate policy to a position of global leadership. The bill supercharges the adoption of proven technologies (solar, wind, EVs), while also spurring innovation of new climate technologies like advanced battery systems, direct air carbon capture, and lower/zero-carbon industrial production.
The bill’s package of tax credits and other incentives will dramatically drive down costs for solar panels, heat pumps, and EVs making them more affordable for households and businesses. The Climate Bill ushers in a whole new era for clean energy in the U.S. especially when combined with the Infrastructure Bill and the Chips Act enacted into law earlier in the year.
With the passage of the bill, the US goes from a laggard to a global leader on climate policy, and from being an importer to an exporter of key components like solar cells and wind turbines. It’s not just the power sector poised to participate: there are suddenly new opportunities for greening across industries, including finance, manufacturing, and real estate.
The chart at left shows analysis from environmental thinktank RMI; climate spending in coming years may actually be significantly higher due to the multiplier effect of public spending, the potential to stack credits, and the uncapped nature of many of the incentives. As many environmentalists note, the bill is by no means perfect, but it represents a monumental step in the right direction.
One area especially to keep an eye on: how US climate policy and spending manage environmental justice implications. The bill contains a $47 billion provision for environmental justice, specifically to provide support for “energy communities” and communities that are “affected by the earliest impacts of climate change and less equipped to adapt.”
What’s very clear: there will be more and more opportunities to invest in the green economy as the transition accelerates even more from here. As The Atlantic’s Robinson Meyer concludes in the recent The Climate Economy Is About to Explode, “The fight against climate change is going to change more in the next four years than it has in the past 40. The great story of our lives is just beginning. Welcome aboard.”
