Although the press is now focusing on the new Omicron coronavirus variant, which has rekindled fears of a new chapter of the pandemic, November also brought disappointment over COP26. The fact is that the 26th UN Climate Change Conference, to give it its full name, came close to complete fiasco. The reason was the thorny issue of coal: it is an alternative to natural gas, whose prices have risen 130% so far this year.
Concomitant with COP26, the magnitude of the recent surge in international carbon prices surprised observers. Many thought it unimaginable that an energy resource often described as outdated and thought to be without any future could feature at all amid the unprecedented and international awareness over climate change.
So far, the main weapon in limiting greenhouse gas emissions has been the establishment of a carbon market, but outside Europe it has had limited success. The most powerful engine of change may prove to lie elsewhere: the ability of the financial system to direct investment towards more ‘virtuous’ actors via the environmental, social and governance (ESG) criteria that originated in the 2006 Principles for Responsible Investment (PRI). Although discrimination in favour of ESG criteria was long seen as marginal, this is clearly no longer the case. Most institutional investors now regard them as a necessary factor in investment decisions. There are now more than 4,000 PRI signatories that can certify their funds as ESG-compliant, and the assets under ESG management rose to a record level at over 0 trillion this year. Does this mean that the financial system can play a leading role in changing business models in a way that limits global warming? It all depends on the credibility of these criteria and the markets’ ability to avoid ‘greenwashing’.
With 97.5% of the S&P 500 having published at the time of writing, the Q3 results season for US companies is all but finished. It has undoubtedly been an exceptional quarter. Profits largely exceeded analysts’ expectations: EPS growth came in at 39.6%, compared with an end-September forecast of 28.5%. The same was true of sales, which were up 17.8% compared with 14.9% expected at end-September. This was the second-largest increase since FactSet started publishing this series in 2008.
Investors are clearly delighted with this good news and drove American share prices to new highs before fears over the Omicron variant and new restrictions aimed at tackling the fifth wave of the pandemic undercut the main indices. All in all, the US market ended November virtually unchanged on the month (-0.8% for the S&P 500); European markets corrected by more (-3.3% for the Euro Stoxx). 30-year yields eased 20bp in the USA and by 10bp in Europe, offering reassurance to investors over the sustainability of historically high multiples.
Notwithstanding this combination of good microeconomic news and lower borrowing costs, our valuation model still suggests that consolidation is possible in the US market. In contrast, European equities appear undervalued irrespective of the economic scenario, with upside potential worth around 15%. Just like last month, therefore, we continue to overweight European markets against their American counterparts.