Essex Global Environmental Opportunities Strategy (GEOS) October 2022 Update
After recovering early in the third quarter of 2022, the global equity market corrected in September, as investors obsessed over hawkish global central bank actions to cull this year’s inflation spike with concerns of a resultant global recession. Market volatility has been exacerbated by the ongoing dislocations stemming from the Ukrainian war’s energy crisis and the lessening yet continued labor and supply chain issues from the pandemic. While it is always dangerous to state “it is different this time”, the current predicament is due to non-economic factors which caused labor and goods supply imbalances. Our Federal Reserve has but one weapon to abate inflation, and the stresses on our economic system reared their ugly heads in the third quarter.
Over the past 24 months, it has become increasingly common for countries and corporations to make commitments to reach net-zero emissions in the future. With COP27, the 27th Conference of the Parties, beginning in Egypt in early November, there will likely be additional decarbonization commitments over the next few months. According to Climate Action Tracker, meeting all announced 2030 climate targets would lead to 2.4 degrees C of temperature warming by 2100 versus 2.7 degrees C of warming based on enacted policies. There are two takeaways from these estimates of future warming. First, existing climate commitments are not ambitious enough to meet the Paris Agreement goal of limiting temperature warming to well below 2 degrees C. To maintain a realistic chance of meeting the Paris Agreement goal, climate targets must become more stringent and near-term decarbonization action must accelerate. Second, the difference in estimated warming from meeting 2030 targets versus warming based on actual policies demonstrates the net-zero commitment versus action gap. Many countries and corporates setting targets forget that setting a climate target, by itself, does not reduce emissions. To decrease emissions and meet 2030 targets, short-term action must be aligned with future climate goals through policies and strategies. Countries and corporates must start bending the emissions curve today with viable clean technologies such as solar and wind energy, electric vehicles, heat pumps, and battery storage. For governments, this means enacting tangible policies that will drive emissions reductions over the next few years. Meanwhile, companies must establish short- and medium-term climate targets to ensure they are progressing on their future net-zero goal now, not ten years from now.
Despite the significant work ahead, the US Inflation Reduction Act (IRA) is one example of recent momentum to reduce emissions in the short-term. The Princeton REPEAT Project estimates that the IRA will close two-thirds of the remaining emissions gap between current policies and the 2030 US target to reduce emissions by 50-52% compared to 2005. While the IRA alone will not ensure the 2030 US climate target is met, it is a good example of closing the commitment versus action gap and ensuring emissions decrease over the next few years.
While the market prognosticators pontificate that stock prices for equities are back to 2020 levels, we point to smaller growth stocks that are at early 2017 levels. While some valuation compression is warranted due to increased costs of capital, we strongly believe our holdings are discounting not only the already-experienced upticks in rates, but an economic recession. The intra-quarter drawdowns for GEOS have at times outpaced the broad market, while our investment thesis grows stoutly amidst mega-trends strengthening from many perspectives and facets. For example:
Global energy crisis: our world is experiencing the most destructive energy crisis in many years. In the E.U., some regions are seeing over 400% year-on-year increases in electricity rates, which is leading to eroding economic footing for consumers and businesses alike. The energy crisis is also demonstrated in the U.S., as severe weather has disrupted power grids from Florida to Texas and California. The energy crisis is linked to geopolitics and climate change and is exacerbated by electrical grids that can’t keep up with the problems or even the solutions. GEOS has exposure to solutions for this crisis, and the power technology theme, at over 30% is our highest conviction solution set.
High prices: Costs are still pressured, from labor to natural resources and materials of all sorts. While much of this is pandemic related, we believe a massive global restructuring is at hand, where our economy continues to transition from just-in-time to defensive production management. In this new era, companies will seek to optimize production and service quality by broadening their suppliers, to production close to their customer bases. As our economy approaches full employment, we are entering a stage of chronic work shortage, given Boomer retirements, lower immigration and declining birth rates. Since 2010, the working population has flattened and may go negative – businesses must optimize productivity to survive. Our very definition of clean tech, is “doing more with less.” GEOS has significant holdings of companies helping to lower input costs for industries and companies, from farmers to retail fulfillment centers. Industrial robotics and asset tracking solutions enable companies to optimize efficiencies, from supply chains to customer shipping.
Severe weather: It is getting hotter. Flooding this year has been biblical, from the southern U.S. to Pakistan. Global droughts are making flooding worse, as droughts kill plants and leave a barren landscape. This reduces soil absorption and makes it easier for water to runoff. There was talk this summer of the flooding in Dallas being a 1,000-year event. Given climate change however, previously defined recurrence intervals based on historical data no longer apply. Our hurricane season here in North America was quiet until last week. A warmer world is a wetter world. For every 1-degree F increase in temperature, the air can hold 4% more water – the result is more extreme precipitation (source: Clausius-Clapeyron relation). Our wildfire “season” is now almost a yearlong here in North America, and Europe is experiencing fires in new areas. Water levels are so low in France that commerce has slowed along water ways. Climate resilience, adaptation and mitigation are the very essence of our investment philosophy for GEOS. Infrastructure hardening, lower emissions commerce, new and distributed energy, water reuse, access and management are all important exposures in the Strategy. As we have posited, in the face of global chaos, we continue to hone our GEOS investment process.
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.
 Climate Action Tracker, Despite Glasgow Climate Pact, 2030 climate target updates have stalled. 2022
 Princeton REPEAT Project, Preliminary Report: The Climate and Energy Impacts of the Inflation Reduction Act of 2022. 2022
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