Market Update and Sustainability Metrics

The past few weeks have been very challenging in the market.

The tech-heavy Nasdaq is now down more than 10% over the past month, while the S&P 500 is down close to 9% from its recent high. This is due in part to economic uncertainty and higher interest rates. 

The debate in 2021 was whether or not inflation was transitory. Turns out that inflation is real and much more stubborn than initially thought.

Inflation for 2021 was 7%, which was much higher than in 2020, when it was at 1.4%, and well above the historical trend of the last 20 years which has been 2.2%.

The Federal Reserve’s fearless leader, Jerome Powell, has responded accordingly and has taken a much more aggressive stance on increasing rates over the next year. This has spooked the markets, causing the 10-year bond to jump from 1.5% to 1.8% in a matter of days.

The Federal Reserve’s main tool in taming inflation is managing interest rates. Higher rates make borrowing more expensive, and can start to cool off an overheated economy.

As you can imagine, the stock market doesn’t like higher interest rates. This is especially true for the more growth-oriented, innovative companies that trade at higher multiples. 

Even though the Fed hasn’t raised interest rates yet, the market is forward-looking and does a good job of pricing in rate hikes ahead of time. At this point, it would be a major surprise if the Fed doesn’t increase interest rates.

Another tool that the Fed uses is quantitative easing. This is the practice of buying bonds on the open market to keep interest rates low. Recently, the Fed has started to wind down its bond buying, which has also caused rates to increase.

What Now?

Does this mean you should go to cash or stop investing?

Market corrections are a healthy part of investing, and can help shake out some of the excess that we’ve seen over the past couple of years. However, this doesn’t necessarily mean we are heading into a recession or bear market.

According to analysts at Deutsche Bank, the stock market has historically been very strong after the Fed has started to raise rates and has averaged a return of over 7% in the following year.

Another Dot-Com Crash?

There have been a lot of comparisons made to the dot-com bubble in 2000. I think some of these are accurate, but others don’t make much sense.  

The GameStop saga, spending thousands on digital jpegs in the form of NFTs and rampant speculation in cryptocurrency seems to be more analogous to what we saw in the late ‘90s.

In the 90s, the stock market’s sky high valuation was based solely on the number of people visiting websites and the potential business prospects of the web.

Now, we are living in an era of exponential growth in technology that is actualizing many of the dot-com era ideas. Companies today are held to much higher standards in the often unforgiving public markets.

Tech = High ESG Ratings

Innovative companies have some of the highest ESG and sustainability ratings because they help dematerialize the world, drive efficiency and improve the standard of living for everyone.

Technology is a massively deflationary force, which is why until recently, inflation hasn’t been much of an issue over the past 20 years.

The 1991 RadioShack ad below is the perfect example of how technology has driven down the price of goods over the past 30 years.

The smartphone in your pocket literally takes the place of almost everything you see in the picture at a fraction of the overall cost.

Impact Fiduciary’s Portfolios

Impact Fiduciary invests in diversified global portfolio of sustainable stocks, bonds and alternative investments. Recently, weakness in some of the more innovative areas of the portfolio as well as fixed income has hurt performance.

Impact Fiduciary is proud to not have any exposure domestically to the fossil fuel energy sector or related companies. Unfortunately, this has hurt relative performance against major indices over the past year, since the fossil- fuel-led energy sector ended 2021 with a gain of 55%.

Investments in clean energy have been great over the past three years, but have underperformed sharply in the last year.

The Invesco Solar Index (TAN) was down about 25% in 2021 and the iShares Clean Energy ETF (ICLN) was also down sharply. The same indices had a strong year in 2020, when they were up 233% and 141%, respectively.

Despite recent setbacks, clean energy still appears to be on an exponential path to disrupting the incumbent fossil fuel companies.

In the long run, my hope is that we can break our collective addiction to oil and harness the clean and abundant energy of the sun before we destroy the earth.

Three year comparison of iShares Clean Energy ETF (black line) with the Fossil Fuel Energy Sector ETF (green line). Source: www.fidelity.com

Clean energy Stumbling Blocks

President Biden’s Build Back Better Plan, which would have been the US government’s biggest-ever investment in fighting climate change, was shelved after the US Senate failed to get the necessary votes.

This would have been a $555 billion dollar down payment on the clean energy transition, but as of now it is zero.

Locally, California, which is usually a leader in clean energy, proposed changing the net metering rules for solar owners. This would effectively disincentivize people from going solar by making it more expensive and adding costs for people who have already made a major investment in solar.

There is still hope! It looks like the US Congress may try to pass a separate climate bill before the end of the year. And after a major backlash, California has delayed voting on the net metering issue.

Fixed Income

Owning fixed income or bonds has also dragged down performance.

The price of bonds shares an inverse relationship with interest rates. As interest rates increase, the price of bonds goes down, and vice versa.

So why would anyone want to own bonds in a rising interest rate environment?

The reason is that no one can predict the future. 

Bonds play an important role in managing risk and diversifying. Typically, when the market sells off, fixed income will provide some stability and downside protection.

A recession or bear market is generally accompanied by lower spending, which is deflationary. This usually causes the Fed to cut rates in order to stimulate the economy which can offset risk in the equity markets and lower volatility.

Impact Fiduciary’s Impact

So how does Impact Fiduciary actually invest in a better world? It’s one thing to talk a big game about sustainable investing, but what does that actually mean?

According to Ethos, which provides third party ESG reporting and ratings, Impact Fiduciary’s aggregate stock portfolio has an overall portfolio score that is 45% more sustainable than the All World Stock Index.

The graphic below shows how Impact Fiduciary’s clients are actually making a major difference with their total investment across all accounts.

Final Thoughts

The recent portfolio performance has been frustrating, but as always, it’s important to zoom out and look at the big picture. This means sticking to the strategy, keeping a long-term perspective and not worrying about the things you can’t control.

I’ve shared this picture before, but I believe it’s always a great reminder. Thanks for reading!

Disclaimer: This article is provided for general information and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. I encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from Patrick Dinan, and all rights are reserved.