Active Thinking

At GAM Investments’ latest Active Thinking forum, David Dowsett evaluates what we might expect for the rest of the year and the implications of the collapse of FTX, while Stephanie Maier highlights key learnings from COP 27 as the summit draws to a close, including a focus on ‘loss and damage’ and the interlinkage between climate and nature.

18 November 2022

David Dowsett, Global Head of Investments

We saw several key events last week, most notably for macro markets the release of the latest US CPI data. Although inflation continues to run at a high level, the month-on-month number was, for the first time in a long time, marginally lower than market expectations, particularly driven by lower inflation in health services. We also saw a dramatic move in markets on Thursday, somewhat exacerbated by the fact that Friday was a Treasury holiday due to Veterans Day in the US. We saw a short covering scramble and very strong performance of all long duration assets, including technology equities as a result. This gave some momentum to the idea that the Federal Reserve can increase rates by 50 basis points (bps) at the December meeting rather than the 75 bps feared and can begin to focus on the forthcoming reduction in inflation that we are likely to see in the first months of 2023.

It is also worth highlighting that there are a limited number of trading sessions left in 2022. This is not only because of Thanksgiving later this month, but also because of the upcoming FIFA World Cup. From an emerging markets perspective, countries will not trade on individual days when their respective teams are playing. The World Cup is thus an important event in terms of reducing liquidity in many markets. Further, from a global perspective, 2022 has been an extremely challenging year for markets and liquidity providers are not incentivised to take on too much risk at this point in the year. Our expectation for the remainder of 2022 is for markets to remain volatile and relatively illiquid but at the same time, more likely to go up than to go down.

Support to risk sentiment comes from the events in China over the past week, including the 20-point reopening plan that has been mooted and the 16-point plan to help the property sector released this week. This is currently only structural schematics rather than underlying detail, but it is a positive surprise and points towards more positive growth momentum in China for 2023.

The US mid-terms were also positive in the sense that voters did not elect the more polarising candidates and from a purely economic perspective a divided Congress is seen as a good outcome. It essentially limits politicians’ ability to take action and less scope for fiscal expansion helps stabilise Treasury markets.

Last week we also saw the collapse of cryptocurrency exchange FTX, from which I draw two implications. First, it is another example of what can happen when the tide goes out on liquidity and the structural weaknesses in business models are revealed. We should expect to see more of this as liquidity continues to tighten in 2023. Second, I do not think this is systemic or that the crypto universe has systemic issues. Some private equity investors have undoubtedly lost money on this individual firm, but we do not believe it extends further than that. Bitcoin and the crypto universe more generally are currently experiencing a lot of tension, but in my view it does not invalidate the concept. It is notable that the extent of declines seen in Bitcoin in recent days from its highs are almost exactly the same as the extent of the declines witnessed in the Nasdaq in 2000 – essentially, it is typical deleveraging from a hugely overvalued level. In my view, the right mindset is to look at opportunities rather than to write off the crypto phenomenon.

Stephanie Maier, Global Head of Sustainable and Impact Investment

Expectations coming into COP 27, currently in its second week in Egypt, were not as high as those for COP 26 in Glasgow. There are a number of reasons for this, including the Ukraine-Russia conflict and the energy crisis that has ensued as well as the broader backdrop of inflation. One of the biggest concerns going into the negotiations was that climate was going to be deprioritised as an issue among global leaders.

Addressing climate change depends significantly on government commitments and policy. It was signposted at COP 26 that nations should come back with stronger, more ambitious targets. The nationally determined contributions (NDCs) before COP 26 were estimated to keep us to 2.4 degrees Celsius of warming. We have had very few increased or improved targets come through prior to COP 27, and the additional targets we have seen have been minimal and have not changed the dial on the 2.4 degree assessment as indicated by the Climate Action Tracker.

However, the position that accelerating decarbonisation is critical to addressing the current energy security and cost issues, is positive. The European Union made a strong commitment to accelerating the green transition to reduce dependency on Russian gas in its May REPowerEU plan. The UK prime minister, Rishi Sunak, stated that “climate security goes hand in hand with energy security” in his COP 27 speech. US President Biden’s speech on 11 November, on the back of better-than-expected mid-term results, gave a strong rallying cry around climate. Under former President Trump, the US was largely missing in action around the climate debate but we are seeing it return to a leadership position. During the summer, the US also passed the Inflation Reduction Act, which has so far been underestimated. The Act demonstrates that the US sees decarbonisation as a market and economic opportunity. We think there is a lot more to come from the US in terms of climate. Following Australia’s change of government, it is also back on the map regarding climate. We think this crisis should lead to an acceleration of the energy transition, as well as action from broader sectors in relation to decarbonisation.

Some of the other issues that have been more in focus, in part because the summit is hosted in Egypt, are ‘loss and damage’. There has been more support for the fundamental view that developed economies have driven a lot of climate change in terms of emissions associated with their activity, but we are seeing developing nations bear the brunt of the physical impacts. We will see this week whether this translates into a firmer funding facility. One of the other big issues brought up at COP 26 was the fact the USD 100 billion in climate finance pledged by developed nations has not been delivered. Climate finance is important because large scale investment is required by both public and private sectors to address both emissions reductions and adaptation to the adverse impact we are already experiencing.

There were a number of announcements made at COP 26 around methane, ceasing deforestation and some specific initiatives on agriculture and sourcing for electric vehicles. Generally, there has been a lower private sector profile at COP 27. But COP27 has served as a milestone to provide progress updates on a number of important initiatives, such as the Net Zero Asset Manager initiative (NZAM) on the next wave of interim 2030 targets, as well as from the Net Zero Banking Alliance. These are scrutinised by broader civil society and we are seeing some of that commitment being translated into more specific targets and plans.

Last year, we also saw the Transition Plan Taskforce (TPT) announced in the UK. We are seeing a number of companies publishing their transition plans and in some cases putting these to shareholder vote. TPT launched their disclosure framework last week and the aim is that it becomes a gold standard for private sector transition plans (not just in the UK).

Overall, while there are not many expectations of big turnkey decisions as a result of COP 27, and there are indeed concerns that the communique will lack in ambition, it has served to put the focus on financing adaptation, loss and damage and the reliance on nature. In December, we have the COP 15 biodiversity summit in Montreal and there is hope that this may serve as a ‘Paris moment’ for biodiversity where we see a lot of that framework and mobilisation that we have seen behind climate change happen for biodiversity as well. There is a lot more recognition of the need to focus on food systems which are clearly very dependent on both climate change and nature and biodiversity. Food and agriculture are already being impacted by more severe weather, for example the high temperatures and drought in Europe over the summer impacted crop yields. We had the first agricultural day in COP last week so the interlinkage between climate and nature is rising up the agenda.

The last thing to note on COP 27 is that given we have both the national levels of government pledges and increasingly corporate pledges on net zero, there was an announcement by the UN working group with the International Organisation of Securities Commissions (IOSCO) to establish a body that would review how credible net zero targets are as a response to a broader concern around greenwashing and whether we will see implementation following on from the commitments. There was not a huge amount of detail around what that might look like but it underpins the need and desire for greater scrutiny of how both countries and companies are implementing their commitments.

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The information in this document is given for information purposes only and does not qualify as investment advice. Opinions and assessments contained in this document may change and reflect the point of view of GAM in the current economic environment. No liability shall be accepted for the accuracy and completeness of the information. Past performance is not a reliable indicator of future results or current or future trends. The mentioned financial instruments are provided for illustrative purposes only and shall not be considered as a direct offering, investment recommendation or investment advice. The securities listed were selected from the universe of securities covered by the portfolio managers to assist the reader in better understanding the themes presented and are not necessarily held by any portfolio or represent any recommendations by the portfolio managers. There is no guarantee that forecasts will be realised.

David Dowsett

Global Head of Investments
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Stephanie Maier

Global Head of Sustainable and Impact Investment
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