BNP AM

The sustainable investor for a changing world

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This material is intended for Institutional Investors (as defined in the Securities and Futures Act, Chapter 289 of Singapore) only and is not suitable or intended for persons who do not qualify as such.

Early January will probably see the sign-off on the much discussed Build Back Better Plan – one of the most important pieces of legislation that could position the US as the environmental innovation powerhouse of the world.  

Proposed by US President Joe Biden ahead of his inauguration, the plan focuses on social services and allocating funds towards reducing the effects of climate change. In our view, it could be a major catalyst for a re-rating of stocks in the environmental space.  

Since we advocated for adding to environmental solutions markets in May after the macroeconomic fallout from rising inflation, we have seen a 24% increase in the iShares Clean Energy Index versus a 36% increase in the BNP Paribas energy transition strategy through the end of October. This compares with a 7% gain for the MSCI ACWI (EUR) over the same period.

Risk/reward appeal

Since early November, however, there has been a significant drawdown similar in magnitude and speed of -16% in iShares Clean Energy and -15% in the energy transition strategy (se Exhibit 1). This was triggered by factors including Omicron, worries over inflation, uncertainty ahead of economic data releases and the next US monetary policy meeting.

Swings in Sino-US rhetoric between hot and cold did not help. In addition, there has been climate policy uncertainty with protracted negotiations in Washington.

This sets the stage for a potential significant opportunity as the gap between iShares Clean Energy (-21% year-to-date through November) and MSCI ACWI (EUR) (+15% year-to-date through November) is as wide as it was in May, meanwhile, the BNP Paribas energy transition has outperformed the theme by 19%, being just -2% year-to-date.

We believe this setup gives the environmental solutions space an interesting risk/reward.

En route to a Santa rally?

While the recent COP26 climate conference in itself was impactful, we see a significant number of catalysts on the horizon such as: 

  • ‘Build Back Better’ (BBB) resolution before Christmas
  • US residential Net Metering resolution by the end of the year with a formal decision in January
  • Broader tax-loss selling is behind us
  • Omicron concerns are receding  
  • Loosening of monetary policy in China in the form of an easing of the reserve requirement ratio (RRR) by People’s Bank of China on 3 December
  • Significant amounts of de-grossing of portfolios into year end and in our minds
  • A ‘de-risked’ US FOMC meeting on 14 December relative to hawkish expectations with regard to prolonged inflation, an accelerated taper of asset purchases and interest-rate increases. 

Combined with attractive valuations across the environmental space, we believe there is a significant probability of a ‘Santa rally’ into year-end and beyond with the environmental theme outperforming markets significantly.

Build back better 

At the time of writing (7 December 2021), media reports are suggesting that the much-awaited US Build Back Better plan could be voted through ahead of Christmas.

On 3 December, Politico reported that Senate Majority Leader Chuck Schumer reiterated his intentions to put the USD1.7 trillion childcare, climate, education and healthcare bill on the floor and pass it before Christmas. According to another report, Senator Sherrod Brown is confident the nearly USD 2 trillion Build Back Better bill will be passed soon, according to The Vindicator.

On the climate portion of the bill, it today includes the following: 

  •  USD 300 billion in tax incentives for producers and buyers of wind, solar, hydrogen and nuclear power, and for purchasers of electric vehicles, who would get up to USD 12 500 in tax credits
  •  A USD 29 billion Greenhouse Gas Reduction Fund that will help state, non-profit and local climate finance organisations invest in emissions-reducing technologies
  •  USD 20 billion in workforce development funding for jobs in climate resilience and mitigation
  •  USD 19 billion in home energy efficiency and electrification rebates, funding for new transmission lines, and investments in advanced efficiency technologies
  • USD 16 billion to help farmers and rural electricity cooperatives and businesses transition to clean energy  
  • A framework to bolster natural solutions to climate change through investment in coastal restoration, forest management and soil conservation, including smart agriculture that could reach 130mm acres of cropland
  • Language that permanently bans oil and gas drilling in the Arctic National Wildlife Refuge and federal waters in the Pacific, Atlantic, and Eastern Gulf of Mexico.  

Clearly, the tax incentives would significantly boost the growth and market penetration in hydrogen, solar and wind.

Tax loss-selling

This is the process of strategically selling investments at a loss to reduce the taxes owed on investments you sold at a gain and repurchasing similar assets.

This all has to happen before 31 December and our market checks indicate that this has put major pressure on the environmental space, which has seen a significant sell-off resulting in losses that can be used to offset tax liabilities.

What is US residential met metering and why does it matter?

Net metering is a mechanism that credits solar energy system owners for the power they add to the grid. If a PV system generates more electricity than the home uses, the electricity meter will run backwards to provide a credit. Customers are only billed for their ‘net’ energy use. On average, only 20-40% of a solar energy system’s output ever goes into the grid, and this exported solar electricity serves nearby customers.

We note that in certain US states there is legislation that would ultimately reduce this compensation to households and jeopardize the government’s decarbonisation plans. There are signs that this is extremely unlikely to be as harsh as feared. If that is the case, we could see a substantial rally in the solar space. Even if there are meaningful changes, it would likely just speed up the adoption of battery usage to avoid selling power back to the grid – another theme we are invested in.

Policy easing in China

There are more signs of policy easing in China, with policymakers signalling that they will loosen real estate market curbs, while pledging to maintain both a ‘proactive’ fiscal policy and ‘flexible’ monetary policy in the coming year.

After the recent cut in the reserve requirement ratio for most banks , hopes of more easing measures have helped to fuel a sharp rally in Hong Kong stocks , with the Hang Seng posting the largest daily increase since early October and the Hang Seng Tech index jumping by more than four percent.

De-grossing – Less overhang now

Portfolios have seen significant de-grossing and Commodity Trading Advisors have created havoc across asset classes with outsized moves in oil prices in particular, but also by taking down major equity exposure.

This leaves much less overhang with the distinct possibility of seeing new highs in equity markets before year-end.

De-grossing occurs when investors take risk off the table, and for CTAs, it can also be triggered by an increase in volatility, as we have seen over the last few weeks.

US Federal Reserve – In for a surprise?

The Federal Open Market Committee meeting on 14-15 December will be held after the latest inflation data and with expectations already on the hawkish side, we see potential for a surprise resulting in what we have seen so many times in December: a Santa rally.


Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. This document does not constitute investment advice. The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns. Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions). Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk. This material is produced for information purposes only and does not constitute: 1. an offer to buy nor a solicitation to sell, nor shall it form the basis of or be relied upon in connection with any contract or commitment whatsoever or 2. investment advice. It does not have any regards to the specific investment objectives, financial situation or particular needs of any person. Investors should seek independent professional advice before investing, or in the absence thereof, he/she should consider whether the investments are suitable for him/her.

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