GEOS April 2020 Outlook

GEOS: Our Current Outlook

April, 2020

We are amidst unprecedented times. The COVID-19 outbreak has indeed affected economic growth for the near-term in unprecedented fashion, and will undoubtedly cause continued dislocations from social to economic. While the sudden degree of the collapse in all aspects, from social to economic is extreme, and will lead to multitudes of changes, we believe one can potentially lose focus amidst chaos. Most predictions overstep rational bounds as they are not based on objectivity, and are often set by those looking to stand out from the crowd. We believe our thesis, philosophy and process of investing to trends that enable economies more output with fewer resources is now more important than ever. We believe clean tech will…

After a positive 2019 for equities which was mostly led by the largest of the tech stocks, 2020 opened in somewhat flat fashion in terms of volatility and volumes.Until the March correction, the market was more democratic than that of 2019, and the smaller and mid-cap sized firms not only participated, but led market returns. As we have been pointing out, this new dynamic was warranted, as growth rates are greater for smaller companies with more favorable valuations.

As March unfolded, the global sell-off did not initially impact the Essex Global Environmental Opportunities Strategy (GEOS) to the degree it affected the larger market given the backdrop mentioned above, but as with all severe corrections, forced selling eventually affected Strategy-relative performance late in the month. In early March, in anticipation of market dislocation, we sold some holdings with significant exposure to commercial and industrial spending. As the correction continued to unfold, we added to high conviction positions with valuations that we believe will be later viewed as unprecedented, such as Hannon Armstrong, Generac and Kornit Digital. In these cases, their stock levels were brought back to five-year lows and while the short-term outlooks are cloudy, we believe the stock prices were unduly punished.

 

“In the middle of difficulty lies opportunity.”

Albert Einstein

 

As the COVID crisis unfolds, we believe the equity markets are presenting value we have not seen in a decade or more. We believe we are close to an equity market bottom, yet think this economic dislocation could not be more dissimilar than 2008, as it is entirely demand-led as the consumer has hit the proverbial wall on spending. Given historically-high fiscal and monetary stimulus, we do expect a robust economic recovery about two quarters post the COVID curve peak. In China, the recovery is underway as stores, factories and supply chains have been reopened for several weeks.

 

Clean tech is the greatest long-term secular trend we believe, and will only be enhanced post COVID. The need to optimize resources is increasing, and will be catalyzed post-COVID. As with Brexit and the trade skirmishes of the past year, opaque visibility places a premium on management tactical and strategic skills, important attributes for companies that can be more nimble than their peers in operating practices. As our global economy emerges from this historic crisis, companies will need to optimize their operations from supply chains to distribution platforms. Factory automation and asset tracking, whether for supplies or goods for shipment will be key trends as we emerge from this crisis. Companies will be placing a premium on capital efficiency, so any investment will need to immediately have substantial return. As labor re-hiring will be tepid given a protracted period of social distancing, we believe companies will continue invest in factory and industrial automation.

 

As the COVID crisis moved from Europe to North America, the fossil fuel shot heard round the world occurred. The recent price war between Saudi Arabia and Russia has caused a sharp ramp in oil production at a time when the economic contraction has destroyed demand, leaving the oil patch in extremely rough shape. As oil prices approached $19 last week with signs of significantly more demand destruction on the horizon, many oil companies are essentially bankrupt, and we expect a wave of defaults and restructurings. While many large fossil fuel companies have provided nice yields as their growth rates have slowed over the past cycle, we believe most all companies such as Exxon Mobil will cut dividends as they stem the tide of profitability. Over the past few weeks, firms from Occidental Petroleum to Southwestern have announced dividend cuts.  Unlike past cycles however, the outlook for the fossil fuel producers is further clouded by the continued declines in the costs of renewable energy. We expect the trend to clean and renewable energy to accelerate from here. Given the increased competitiveness of renewables, most countries share of energy from renewables is already above 2020 targets. For example, the U.K. now generates over 14% of energy from renewable sources according to Deutsche Bank research. The most important fossil fuel demand destructor is yet to come, and this is one that we expect to be the most important clean tech trend of the coming decade – the rise of the electric vehicle. While EVs are a mere 2% of global auto production today, we expect the costs of EVs to be at parity with internal combustion engines (ICE) within three years. Costs are declining so rapidly for batteries we have recently shortened the trajectory for cost parity by two years. While global auto manufacturers are amidst a temporary demand crisis for cars, they are increasing plans and spending for EV production in the next model year. Automotive manufacturers are doing what they have never done before – they are forming strategic alliances with other manufacturers to ensure supplies of important battery materials such as lithium, and are securing long-term contracts with vertically-integrated battery manufacturers. Importantly, electrification of mobility cuts a broad swath, spanning well beyond passenger cars to include fleet and public transport, off-road vehicles, as well as stationary power storage. We have significant exposure to electrification in the Fund, and expect to increase exposure in the coming months. As the Einstein quote above demonstrates, we believe the diversified clean tech themes to which we have invested to solve the world’s most vexing problems will reward long-term investors.

 

 

 

Disclosures:

This commentary is for informational purposes only. It does not constitute investment advice and is not intended as an endorsement of any specific investment. The opinions and analyses expressed in this commentary are based on Essex Investment Management LLC’s (“Essex”) research and professional experience, and are expressed as of the date of its release. Certain information expressed represents an assessment at a specific point in time and is not intended to be a forecast or guarantee of future results, nor is intended to speak to any future periods. Accordingly, such statements are inherently speculative as they are based on assumptions that may involve known and unknown risks and uncertainties. This does not constitute an offer to sell or the solicitation of an offer to purchase any security or investment product, nor does it constitute a recommendation to invest in any particular security. An investment in securities is speculative and involves a high degree of risk and could result in the loss of all or a substantial portion of the amount invested. There can be no assurance that the strategy described herein will meet its objectives generally, or avoid losses. Essex makes no warranty or representation, expressed or implied; nor does Essex accept any liability, with respect to the information and data set forth herein, and Essex specifically disclaims any duty to update any of the information and data contained in the commentary. This information and data does not constitute legal, tax, account, investment or other professional advice. Essex being registered by the SEC does not imply a certain level of skill or training.