A bounce back for sustainability: Three investment ideas for 2024

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This report was produced by researchers at Montreal-based Sustainable Market Strategies, which performs market analysis about sustainable investing for investment managers, institutional investors and investment advisors, given the growing appetite for sustainability-focused investments.

Last year will surely be remembered as one of market divergences. While global equity indexes delivered returns in the mid-teens, this masked a catastrophic year for many renewable energy plays, the explosive performance of the “Magnificent 7,” and much muck in between.

To be sure, economic and financial market performance can be chalked up to the extreme optimism surrounding artificial intelligence as well as a resilient U.S. consumer. (Neither of these factors are likely to be in such force as we head deeper into this year.)

After all, there are signs that generative AI (such as ChatGPT) has already hit the peak in its hype cycle and is set to enter the “trough of disillusionment.”

As for the U.S. consumer, the thick buffers in household budgets thanks to emergency COVID policy measures are wearing thin. The lag has been longer than is typical, but tight monetary policy is showing up in the form of higher consumer loan delinquency rates and less appetite for interest-rate-sensitive purchases.

A mild-to-average consumer-focused U.S. recession would surely temper optimism among equity investors. Here are several sectoral implications and nuances that sustainability investors should consider:

• The impacts of the Inflation Reduction Act will be present for at least the first half of 2024. Re-shoring and building back better continue to be relevant sustainability themes, and these effects are particularly strong in the U.S. The persistent positive impact of the Inflation Reduction Act is one of very few sources of global stimulus.
• That said, a reversal in Biden-era policies, should Donald Trump win the 2024 American presidential election, risks having a significant, detrimental impact on several sustainability themes, including renewable energy, energy efficiency and possibly healthcare plays. This is a key development worth watching beyond Q2.
• The global manufacturing recession is well advanced, while the U.S. consumer recession is just getting started. This pattern is not unique (manufacturing tends to lead economies into and out of recessions), but in light of the ongoing Inflation Reduction Act stimulus, there is a strong case that the manufacturing cycle has already bottomed and is stabilizing while momentum in the consumer sector is accelerating to the downside.

Against this backdrop, we propose three sustainability-centric investment ideas for 2024.

Idea #1: Stay long green industrials, go short wasteful consumer discretionary (but mind the presidential polls)

In 2024, fiscal firepower sits squarely in favour of the industrial sector thanks to the Inflation Reduction Act and pro-climate policies in other countries as well. Thus, on a cyclical horizon, industrial plays, especially those that benefit from the great “building green” retrofit, are well placed to outperform consumer discretionary sectors.

On a longer-term basis, the desire to re-shore as well as greenify key infrastructure means that for the first time in decades, the industrial sector is likely to grow as a sustainable share of underlying GDP.

The year ahead provides a good entry point into this long-term theme. Investors looking to build positions could start with companies tied to essential goods and services, like water and energy efficiency.

Idea #2: Catch the uranium wave

Nuclear power provides 10 per cent of the world’s electricity. Construction of nuclear reactors takes a long time (5 to 10 years) but offers a substantial service life advantage: twice as long as alternatives like solar panels and wind turbines.

About 60 power reactors are currently under construction, with an additional 110 in the planning and 300 in proposal stages. Meanwhile, extending the lifetime of existing plants is highly probable – the original design life expectancy is usually 40 years but can be extended by 20-year increments, and the coming wave of renewals will be critical in supplying enough electricity to meet growing demand.

Increasing nuclear energy capacity around the world means higher demand for uranium. To be sure, uranium demand fluctuates with economic cycles, and 2024 global recessionary conditions are a concern, but uranium supply is currently tight. Alleviating supply-side constraints is not easy since mines take a long time to build and investments were lacking since the long bear market of the 2010s.

The recent commitment made at COP28 by a group of 22 countries to triple nuclear capacity by 2050 underscores an increasing global desire for nuclear energy and the bullish sentiment around this investment.

Idea #3: Regulated carbon markets

Despite being a molecule that affects the climate globally, carbon dioxide (CO2) exhibits fundamental regional differences when it comes to the tradable commodity. In 2023, while European traded carbon prices fell 17 per cent, North American prices (i.e. carbon traded under the Western Climate Initiative) gained more than 30 per cent.

What explains this? The short answer is the correlation between industrial GHG emissions and economic activity. The Eurozone economy fared worse than the North American economy in 2023 and, as a result, Europe’s industrial GHG emissions were lower, and therefore there’s less demand for carbon credits.

For 2024, we expect good returns across regulated carbon markets. In Europe, industrial activity is likely to remain tame, but there are still some other positive factors at work:

• The carbon allowance price is back to its pre-Ukraine invasion price (below 70 euros), after having flirted with 100 euros at the end of 2022.
• France and Germany recently reached key power price deals that should set the stage for increased power consumption by industry from 2024 onward.
• Favorable regulatory adjustments and post-COP28 international momentum should provide the necessary tailwinds to push up the price.

The California-Québec market (WCI) shows even more promise. Even though prices have had a good run in recent months there is still ample upside potential to the unit price. Currently, carbon allowances trade just above CA$52, which is already trailing its European equivalent, and, in addition, the Canadian Carbon Tax scheme will increase to CA$80 in 2024, leaving a comfortable gap to fill on the upside. Moreover, the state of Washington intends to join California and Québec, which should be a bullish event for the North American carbon markets.

Sustainable Market Strategies is a division of SMS Financial Technologies Inc., a privately held financial services and investment firm. The authors of this research note do not personally hold any position in the above-mentioned securities, and neither does Nordis Capital, a sister company to SMS that invests through an ESG (environmental, social and governance) lens. Click here to learn more about Sustainable Market Strategies.

This report should not be considered investment advice or a recommendation to purchase any particular security, strategy or investment product. References to specific securities and issuers are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. Redistribution of this report is prohibited without prior consent.

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