As for most investing styles, monetary and fiscal policy can be huge return drivers for sustainability portfolios. We sat down with Lenka Martinek, managing partner at Sustainable Market Strategies, to discuss the outlook.
How has the macro backdrop evolved over the past year, and how do you see it impacting portfolios going forward?
For most of 2024, U.S. monetary policy had been relatively benign for equity portfolios. The Federal Reserve has basically delivered interest rate policy that was very in-line with financial market participants’ expectations of what would happen. In other words, monetary policy has not been a large source of market volatility in the past two quarters.
However, we think this could change in Q4 and beyond. Whether the Fed can continue to deliver the rate cuts that are expected over the next year largely depends on inflation. The Fed’s preferred measure of core inflation (PCE) is approaching its 2% target, but food price inflation—a major spending basket for consumers—remains stubbornly high. Other measures of inflation also remain lofty, underscoring the possibility that the Fed’s fight with inflation may not be over quite yet.
Meanwhile, the lead-up to the U.S. federal election has been an important theme for investors in 2024, with many jumping onto the “Trump trade” in the spring (that is, taking overweight positions in the U.S. dollar, prisons, banks and oil companies). This effect, however, has petered out now that the race is too close to call. Historically, equity market volatility increases in the month prior to the vote, and this election will likely be no exception.
What do you expect for markets post-election?
Whoever wins the election, there is unlikely to be major fiscal policy change for Q4 2024 and 2025. The Inflation Reduction Act and the Chips and Science Act are huge legislative feats that simply don’t come around very often.
The chart below shows that in the U.S., the contribution of fiscal policy to real GDP growth will become roughly neutral in the fourth quarter of 2024 and be mildly negative throughout 2025. The Brookings Institution’s projection shown in the chart assumes an extension of the provisions of the 2017 Tax Cuts and Jobs Act that are set to expire at the end of 2025—an assumption that we find most plausible. Trump has stated that if he wins, the tax cuts will of course be extended, while Harris pledges to re-distribute the fiscal burden among tax brackets. In both cases, overall tax revenues will not look very different.
What do you see ahead for U.S. environmental and energy policy?
Throughout Harris’s campaign, she has been relatively silent on climate change and adaptation, though she appears to have adopted an “all of the above” domestic energy policy approach, one that even includes fracking. This is likely because energy autonomy and national security have broader voter appeal than strict environmental legislation. Meanwhile, Trump has become far less hostile toward green energy and electric vehicles since Elon Musk has become his supporter. In this sense, there may be far less of a divide between the two presidential candidates than is commonly perceived and despite much of the negative rhetoric from Trump.
We expect that capital will continue to support bullish trends in several industries that are involved with climate change and adaptation. A buildout of key infrastructure like the electric grid is necessary, and the companies that are building it will continue to benefit. Investment in the built environment, with a view to better manage the adaptation to more frequent and severe weather events, will also occur out of necessity. Engineering and related infrastructure companies will see the demand for their services rise.
What other areas are you looking at post-election?
We continue to believe that risks favour more air coming out of still sky-high valuations in AI-hyped stocks and the rotation to more defensive plays like healthcare will continue. The healthcare sector helps form the backbone of diversified sustainability portfolios, and we currently like the sector for its defensive characteristics. (It’s hard to cut back on medications and healthcare procedures even when times get tough.)
We also believe there are some exciting micro stories to play out in the next year. One example is the roll-out of the NOPAIN Act, the Non-Opioids Prevent Addiction in the Nation Act. It is a popular, bipartisan legislative effort, aiming to reduce opioid dependence by expanding access to non-opioid pain management treatments. Starting in 2025, separate Medicare reimbursement for FDA-approved non-opioid therapies will be provided, particularly in outpatient surgical settings. Pharma companies that can deliver on non-opioid alternatives should see a liftoff in their revenues starting in Q1 of next year.
Lenka Martinek is an investment strategist with over 20 years of professional experience in research and capital markets. Previously, she worked for 15 years as a strategist for BCA Research, a leading provider of independent global macro investment research, and as a global macro portfolio manager in the CIO office at PSP Investments. Lenka joined Sustainable Market Strategies and Nordis Capital with the conviction that capital markets will play an integral role in transitioning to a more sustainable world. She heads the research efforts of both firms and is a member of the investment committee for Nordis Capital. Click here to learn more about Sustainable Market Strategies.
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