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Five insights in five minutes

Five in Five: inflation, greening China, margins, frontier, climate
12 November 2021

    US inflation

    Giving central bankers everywhere some much-needed perspective, nothing that was said or agreed in Glasgow over the past two weeks has moved financial markets like Wednesday’s US inflation number for October. Headline prices jumped 0.9 per cent month on month, double the previous reading and above consensus by half as much again. Year on year inflation is now 6.2 per cent – a three decade high. That two-year treasury yields rose by almost a quarter in a single session, with ten-year yields jumping from 1.43 to 1.55 per cent, suggests the ‘inflation is transitory’ camp is abandoning tents. But step back. The move in two year notes merely returns yields to a tad beyond the 0.5 per cent they were at the start of last week – that decline had many fixed income traders scratching their heads anyway. Likewise, treasury volatility is barely above where it was in March and well below levels seen before the pandemic, as per the chart below. About half the rise in inflation is due to energy price rises – which will moderate eventually – and post-Covid ‘re-opening’ categories such as used cars, airfares, eating out, and lodging. Still, plenty of heat for the Fed to ponder post Cop26.

    Conversation starter for...US and global fixed income, high yield, credit, equities

    US inflation   For illustrative purpose only. 

    Investing in China

    Napoleon Bonaparte described China as ‘the sleeping giant’ two centuries ago. A ‘greening dragon’ is more appropriate today. Findings from the HSBC ‘Succeeding in China’ survey, published this week, indicate a deepening confidence to invest more in China among international firms. And more than three quarters of foreign companies feel that China’s march towards carbon neutrality makes expanding operations there more attractive (see below). Beijing’s drive to sustainability will spur market innovation and growth, and foreign firms don’t want to miss out. Planned investments put renewables at the forefront, with energy-efficient products and electric vehicles also prioritised. The fact that almost 30 per cent of China’s total consumption of electricity comes from renewable sources already (according to China’s National Energy Administration) shows that action follows words. If China’s carbon reduction pledge is an opportunity for international businesses, as our survey shows, it is also for investors. They can benefit from sustainable development by investing locally, or via foreign companies whose growth will be tied to the expansion and the evolution of the Chinese market.

    Conversation starter for...China equities, climate funds, ESG strategies

    Investing in China   For illustrative purpose only.   

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    Margin rebound

    Are higher production costs impacting corporates’ profitability? If you look at profit margins in the chart below, the answer is no. Even more promising, current profitability levels are around two percentage points higher to what they were before the pandemic, globally. This is certainly the main force behind the ongoing wave of positive surprises in earnings around the world, although in the US the percentage of companies that are surprising has fallen over the past two quarters. There is a long-run correlation between earnings growth and equity returns. But not so for earnings surprises, especially in the short term. The relationship is even negative in America over the past 12 months, as our Strategy team points out in its latest publication. That’s because lots of things drive share prices alongside profitability. And during an economic expansion, such as we’re having now, valuation multiples can have just as big an effect on returns as earnings growth. Indeed, in developed markets ex-US, Asia ex-Japan, and emerging markets ex-Asia, a big contraction in multiples has taken a massive bite out of year to date returns. All of which makes elevated margins today even more important to watch.

    Conversation starter for...global equities, multi-asset funds, emerging market equities

    Margin rebound   For illustrative purpose only. 

    Frontier markets

    A couple of weeks ago, Five in Five highlighted the shortcomings of rich nations in delivering promised energy transition funding for developing countries. This week, African nations, along with a group of developing countries that includes heavyweights China and India, upped the ante. The group has called for USD1.3 trillion in financing per year from 2025, with USD700 million of that towards Africa alone. The world’s second largest continent is responsible for less than four per cent of historical emissions but is suffering some of the most pronounced effects of climate change due to its geography. Venture east and you can find similar stories in countries such as Vietnam, also part of the aforementioned group. With young and growing populations, financing to rewire these frontier economies would create plenty of opportunities. This could further the steady march upwards for frontier market stocks, seen below, which are supported by profit margins over 50 per cent higher than their emerging market peers.

    Conversation starter for...Frontier markets, emerging markets equities

    Frontier markets   For illustrative purpose only. 

    Climate-aware investors

    Some surprising countries committing to ‘net-zero’ pledges, more than 100 nations agreeing to reduce methane emissions, and promises to end deforestation – not a bad report card for governments at Cop26. Now, what can investors sitting on hundreds of trillions of dollars do to help the climate? One strategy is to have like-minded investors band together and exercise pressure collectively to change the behaviour of carbon-emitting businesses. Listed companies with high institutional ownership are a good place to start – shares can be voted and large asset managers are easier to corral. What is more, carbon-intensive industries in the MSCI AC World Index are roughly 60 per cent owned by institutional investors. Making an example of a few big names may also help with stocks that remain state-controlled; these still account for more than two-thirds of emissions. Climate-aware retail investors, meanwhile, should think about delegating the hard work to trusted asset managers. Active funds are one option. Another is buying into ESG ETFs, where choices are abundant and whose assets have grown 20 times to USD390 billion in just five years.

    Conversation starter for...climate change funds, ESG ETFs

    Climate-aware investors  For illustrative purpose only. 


     


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