The Green(back) Boogie

Attempting to read the macroeconomic cycle has historically been an important requirement for public and private investors, including companies when timing portfolio management initiatives. It has been a way to make or lose money, or, more pompously, to create or destroy value.

Things are changing. A new type of cycle is in town. It is not linked to the macro-economic cycle and is arguably more potent. It was in gestation for most of 2019 and born with a bang towards the end of the year. This week’s Davos WEF was its baby shower.

Recent expectations of a turn in the macro cycle have contributed to a rise in optimism in equities, with world indices reaching new peak levels. There has been no material deterioration of the ISM New Order index and of the Eurozone PMIs in December, which suggests that the Western economies are set to bottom out. Furthermore, all reports from China point to a regain in macro optimism (now subject to containing the new coronavirus).

Whilst short-term changes in the macroeconomic sentiment can still drive some excitement, they ought to be put in a cooling perspective. The growth of the global economy is range-bound at a rather anemic level (3.0-3.5% per annum in real GDP terms for the foreseeable future). Furthermore, economic cycles are expected to be more elongated and with a lower amplitude. Lower growth and flatter cycles reflect stagnation rather than stability.

The new cycle referred to above is the ‘ESG cycle’. I am convinced that the sentiment related to ESG factors will follow a cycle, perhaps akin to Gartner’s hype cycle. Accordingly, the focus on ESG matters will first rise beyond reason to create an ESG bubble: Soon it will be ethically forbidden to invest in ninety percent of the stock market; Having children will be frowned upon; and pressing the human race self-destruction button to save the planet might be seen as the only decent thing to do. As the world reverts to its senses after realizing that doom is not as imminent as it seems, the ESG cycle will collapse as interest wanes. After this sharp reset, it will grind higher alongside the ‘slope of enlightenment’ to reach a sensible, lasting level.

This entire process will give rise to a cycle with significant implications for the valuation of all financial instruments depending upon their ESG credentials. It will represent an exceptional opportunity for shrewd investors to generate capital gains, eclipsing the opportunities offered by a flattening macro-economic cycle. It’s the green(back) boogie!

ESG trends are not immune to exuberance. In fact, I would argue that they are particularly prone to it since they are emotionally charged (see also ‘Pascal’s Wager’ in December). In that context, seeing through the ESG cycle will soon represent a new requirement for market participants to invest in equities – with implications for corporate portfolio management.

The Unchained Banker