Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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Black energy takes the lead as green transformation stocks turn negative
Peter Garnry
Chief Investment Strategist
Summary: Our green transformation basket is down 1% year-to-date as rising interest rates have had a negative impact as the companies operating in this segment rely on debt financing and low cost of capital to expand their business. We also talk about the need for the oil and gas industry, which is up 21% this year, in the transition period to a less carbon intensive economy, and that the underinvestment and low return on capital in energy over the past years will lead to higher prices on oil and gas to support the industry. Finally, we take a look at electric vehicles where NIO's earnings guidance on Monday took the market by surprise.
Rising interest rates do not hit industries equally and green transformation stocks have been hit hard the past two weeks as the US 10-year yield has marched onwards. Green transformation stocks started the year with a 15% gain in less than two weeks but operating in the physical world requires a lot of capital and rising cost of capital has a direct impact on opportunities and profitability. When you couple high debt financing requirements with lofty equity valuations then we get an equity segment that is highly sensitive to rising interest rates.
While our green transformation basket is down 1% year-to-date, the MSCI World Energy sector comprising of the old oil and gas industry and its services and equipment companies is up 21% over the same period. This is a stark reversal of last year’s fortunes, but maybe also a sign of what to expect. It might be that governments are incentivizing industry and investors to go all in on renewable energy, but the transition cannot happen without the oil and gas industry providing the necessary ingredients for an efficient baseload of the electricity grid (natural gas). The oil industry is still necessary for society while we transition to electric vehicles and lesser carbon footprint in our industries. The trend in ESG is lifting the cost of capital for companies involved in resource extraction such as oil and gas, and while it is a good thing, it will mean higher cost and less access to capital which means further constraints on supply. ExxonMobil is a good example of this phenomenon with return on invested capital below cost of capital for six straight fiscal years. It might have worked with lower interest rates but if we suddenly get higher interest rates and high demand from stimulus energy prices will also increase drastically and likely extending the momentum in black energy.
Electric vehicles and their constraints
Electric vehicles are part of the green transformation and Volvo’ CEO had a good interview on Bloomberg TV yesterday answering all the critical questions about battery, new sales models impacting dealerships etc. It worth watching if you are interested in the direction of electric vehicles. Aside from Volvo’s CEO comments, we would like to a few things about what is going on in electric vehicles. Sentiment has soured a bit recently and this Monday NIO disappointed on its earnings forecast as competition is pressuring EV-makers in China. Tesla is still leading this emerging category but in 2020 we saw emerging cracks in Europe, with Tesla losing market share to VW and other brands despite a fast growing EV market turning Europe into the largest market for electric vehicles. We think 2021 will be a key year for Tesla, as the most bullish investors have potentially overestimated Tesla’s advantage, and we will get a clear sense of this in the coming months as car registrations are released in Europe.
We all know the constraints on EV production from batteries and other parts such as microprocessors, but something few are aware of, is that we could soon be facing a real constraint on the grid as well. With more heat converters and electric vehicles more demand is put on our electricity grid and especially local transformers which are risking overheating. Many countries are estimating high infrastructure investments in our grid to make society ready for the green transformation. And these investments and capacity needs to be a head of the demand curve not behind if we want to avoid our green transformation to stall.
Previous notes on equity themes:
The commodity sector and the reflation trade in 2021 – 4 January 2021
Bubble stocks go into ‘hyperdrive’ mode – 8 January 2021
Introducing Next Generation Medicine basket – 20 January 2021
Updating our Green Transformation theme basket – 29 January 2021
Launching Saxo’s E-commerce theme basket as more growth lies ahead – 5 February 2021
Be careful of bubble stocks and updating bubble methodology – 12 February 2021
Gaming is a long-term winning industry – 26 February 2021
The 5-year chart below is for regulatory purposes
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