Fall 23′ Market Commentary

The bottom line (at the top)

  1. Inflation and Interest rates are the ultimate drivers of today’s global markets. Institutional and retail investors alike are hanging off every data point from the Consumer Price Index (CPI) reports and every word coming from head of the Federal Reserve, Jerome Powell.
  2. The global clean energy and socially responsible investing thesis is very much intact. However, it is currently out of favour. We don’t believe that this malaise can continue if we are to continue to inhabit this planet.
  3. If you are building wealth or trying to preserve your wealth over a 20-year or longer time frame, then you will not behave with a 2-year mindset.

The seasons are changing

It seems the cost of everything I need to buy is going up. But the cost of everything that I own is going down. Such is the season, I suppose.

As in our natural climate, there is a domino effect when one element shifts – all the other elements must shift with it. This is how we know from an ecologist’s point of view that the biosphere is functioning and adaptive. In the body, a key indicator of cardiovascular health is a metric known as ‘HRV’ or *‘Heart Rate Variability’.* Along with your resting heart rate, or blood pressure, it provides us a peek into the health of the system. HRV is a measure of how quickly your heart can adapt from a state of rest to a state of action. A body that can adapt well to the demands put onto it is a healthy body. An environment that can adapt to a colder weather pattern, or a market that can adapt to changing fiscal and monetary policy, is a healthy one.

But when November comes, the sun goes, the leaves turn, and in fact they die, preparing for winter. What would you think if Thanksgiving came, and we were still eating fresh summer corn on the patio in your shorts and 30-degree weather? You’d reckon something is off, and indeed it would be.

If you’ve been trying not to look at your statements, or the ‘Stocks’ app on your phone, let me catch you up with the weather. We will be doing this more frequently now, but allow me to weave some background narrative.

Back to our 30-degree barbecue in October. That was very much the situation we found ourselves in during the stock markets in 2021 and early 2022. Everything told us we should be heading into winter, and yet, we hit all time highs across the globe. 30-degree weather, in December. We had artificially altered the ecosystem. Political, fiscal and other motives forced our Central Banks in the west and across the globe to oversteer. A pandemic was raging, we didn’t know what to do and were all deathly afraid of the cold winds blowing from beneath our doorstep.

This led to money printing, government stimulus, economic lockdowns and cultural divisions. This then led to an onslaught of societal and economic consequences. To put this in other terms – we fed the body caffeine, asked it to sleep, then hydrated with alcohol before running a marathon.

To the many athletes, doctors and wellness experts we have as clients who are reading this, you can tell me how a person’s health might react to those inputs listed above.

My guess is not well. I can tell you that equity markets and economic systems did not react well, and we have been untangling that mess of the past 18 months as we head into 2024.

Two or twenty?

Some investors are in the markets for two years. They are looking to purchase a home or make some large expenditures in the near future. The overwhelming majority are in this to build or preserve their wealth for the next 20 years or more.

“But I am retired!” – you are, and in that same breath, you are likely to be retired for a long time. We will need to fund that retirement over the next 10, 20, 30 years while outpacing our friend inflation.

As we dive in, it’s critical to be aware of our time horizons and understand the cyclical nature of all things, including investment portfolios.

The current temperature

We can talk about the weather, then we can talk about climate change.

Throughout 2023 we have experienced what we believe will be labelled by history as a B2B (business to business) recession. We have seen downward earnings forecasts, missed targets and surprise downsides in many of the companies that represent the gear-work of the economy.

But the only domino that matters to the market now is Inflation. If inflation runs too hot (which it is), the central banks will raise interest rates to slow the burn. Think of this like dampening the air intake on your wood stove. The fire is still lit, but calmed down for now because the house is overheating. This has been the state of our economy. When the house is too hot, you take off layers, but when you can’t take off any more layers, you ought to turn the heat down!

When interest rates increase, the cost of borrowing for everybody increases. Governments, small businesses, multinational corporations and consumers like you and me.

This means that across the board, profit margins are low or have turned negative. and businesses are fundamentally worth less. As a result, markets decline.

Inflation and interest rates. This has been and will continue to be the center of our conversations. If you understand those two aspects of the markets, you will understand 90% of the drivers of the market in today’s world. Markets will behave very differently when inflation is under control and interest rates start to ease off.

The future is never clear. Investors pay a very high price in the stock market for a cheerful consensus. Uncertainty is the friend of the buyer of long-term values. The markets are simple after all. Buy low, sell high – simple, right?

Well friends we are in the middle of a periodic low, which could continue for the next 9 – 12 months. Despite the challenges of rising interest rates and a body which has started to eat its proverbial greens – we believe it is a good time to be stock pickers. As capital becomes constrained, competitive advantages become more important. Investors are less willing to finance businesses that grow users, production, or other metrics, but have little prospect of turning a profit over a reasonable time horizon. For weaker companies, the only way to survive is to cut costs, downsize, and abandon their growth-at-all-cost strategy. Their market share will be picked up by companies with the right business model and strong competitive advantages. Our investment philosophy focuses on finding those companies with attractive long-term growth prospects, strong competitive advantages, and whose products and services are helping to create a more prosperous and sustainable world. This thesis has never changed.

What about performance?

The market is a tale of two styles. Growth & Value. Growth is being represented by the mega-cap technology and consumer brands (Amazon, Google, Meta, Netflix, Microsoft etc.). This section of the market, largely tracked by the NASDAQ, has had stellar year-to-date performance of 27.27%. (whoa), driven almost entirely by the Artificial Intelligence craze (another topic in and of itself). In the meantime, the Toronto Exchange is up only 0.5% on the year & the Dow Jones up just 1.1%. While this is an imperfect comparison, it illustrates that the real economy is flat, or maybe even contracting, when we look more closely, while the headline stock market numbers are driven by a very select few. Due to the ethical concerns expressed by many of our clients, we do not invest significantly in those technology behemoths.

Relative underperformance compared to the American markets has been closely tied to the growth vs. value narrative. Investors have been pouring dollars into high growth/priced stocks rather than companies producing capital goods for the benefit of the energy transition/grid decarbonization (companies typically found in environmentally focused mandates like ours).

By our analysis, we see a general 20-30 % discount in some portfolio stocks’ intrinsic value below the current average market prices. This environment is very different than the one we have lived in over the past 15-20 years. In essence, stocks are cheap, and right now is an opportunity for clients to take a good hard look at their risk tolerance and decide if they are able to responsibly rebalance their household assets and add to their investments.

What about the green investment philosophy?

The long term drivers of the transition to a more sustainable economy remain very much intact. Recent legislation, such as the Inflation Reduction Act, the Infrastructure Investment and Jobs Act, and the CHIPS and Science Act, are further accelerating these drivers. We maintain a balanced mix of economically resilient businesses as well as companies poised for cyclical growth. We look to invest in companies and industries that can safely navigate the different phases of the economic cycle.

The current state of renewable energy

We live in a fossil-powered world. About 84% of our energy comes from fossil fuel. Roughly 16% of the electricity production worldwide comes from renewables. There is tremendous growth to be expected (long-term) from solar, wind, batteries and other renewable technologies. We must keep in mind that energy consumption and economic growth are joined at the hip, meaning that our energy consumption will continue to go higher and higher (well, at least as long as policymakers consider growth to be a good thing) — see 1 chart below.

80% of the world’s greenhouse gas emissions come from that 84%, meaning that we need to build and scale up solutions that will help us utilize energy in a more efficient way and decarbonize our energy grid over time. As mentioned previously, the recovery from the Covid-19 pandemic and the response to the global energy crisis have provided a major boost to global clean energy investment (62% increase in clean energy investments vs. -20% decrease for fossils between 2015 & 2023) – see 2 chart below.

The bottom line (at the bottom)

Stock and bond markets are suffering the effects of inflation and high-interest rates. When inflation cools and interest rates moderate or decline, markets will act very differently. Shut out the short-term ‘noise’ and focus on longer-term goals. The imperatives of building out clean energy infrastructure and supplying that energy to the grid are not going to change. And in our view, neither has the thesis that companies integrating environmental and social considerations into their business will outlast those that don’t.

The comments and opinions expressed herein reflect the personal views of Joss Biggins and/or Tony Edwards. They may differ from the opinions of Leede Jones Gable Inc. and should not be considered representative of the research beliefs, opinions, or recommendations of Leede Jones Gable Inc. View our full legal disclaimer here.

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