Weekly market commentary

The low-carbon transition is one of five mega forces, or structural shifts, we track for investment risks and opportunities. We’re following three investment themes at the UN climate conference (COP28) in Dubai. First, climate resilience – society’s ability to prepare for and withstand climate risks – is an underappreciated theme, we think. Second, we eye progress on unlocking climate finance in emerging markets. Third, we watch for new policy plans that could shape the transition path.

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Physical damages mount
U.S. events with inflation-adjusted losses over $1 billion, 1985-2023

We highlight climate resilience first because it is an emerging theme not yet fully appreciated by investors. We think companies that create and adopt products and services that boost climate resilience will become a more widely recognized opportunity. Why? The number of U.S. climate events with damages above $1 billion has steadily climbed over the past roughly four decades. See the yellow bars in the chart. As such risks increase, we are seeing early signs of growing demand for climate resilience solutions. Case in point: Demand for home air-filtration appliances in the northeastern U.S. spiked during the Canadian wildfires in early 2023. Emerging markets (EMs) are set to bear some of these risks more acutely given greater exposure to physical climate damage. Yet they face difficulties in raising financing needed for the transition. We think this also offers an investment opportunity and is key to tracking the transition’s overall speed and shape.

The IPCC has reported persistent increases in average annual temperatures, precipitation and sea levels. The frequency and intensity of acute weather events, such as extreme heat and widespread floods, has also increased. We see policy and regulation driving the growth of the market for resilience products. Any COP28 agreement on a global plan for climate adaption could spur new policy. Some incentives to invest in resilience are already in place, including $50 billion from the Infrastructure Investment and Jobs Act and over $20 billion from the Inflation Reduction Act. Other support comes from building code updates in the U.S. and Europe explicitly focusing on improving climate resilience. Read more in our new paper.

EM financing gap

We are closely watching policy developments that could unlock investment opportunities in EMs. They play a pivotal role in the global reduction in carbon emissions, in our view. Why? We estimate EM will account for over half of energy demand and carbon emissions by 2050. Yet transition-related investment in EMs will likely be lower than in DMs due to a higher cost of capital from greater perceived investment risk, and greater exposure to physical climate damage. We think closing the financing gap would require significant public sector reforms and private sector innovation, resulting in greater "blending" of public and private capital. We think successful reforms could see low-carbon investment in EMs rise on average by a further $200 billion a year – or $4 trillion overall – above our base view of a major increase in investment between 2030-2050.

Evolving energy use

We think COP28 will also provide further details about policies that are likely to influence how the mix of energy use evolves – and the investment opportunities. We see policy, technology and consumer preferences driving an accelerating shift to renewable energy in DMs. 2023 has seen record growth of about 50-70% for renewable energy, according to the International Energy Agency. Countries at COP28 look poised to agree to a goal to triple capacity by 2030. We think further policy support may make the goal achievable – and yet the S&P global clean energy index is down about 28% year to date, LSEG data show. Even with this growth in renewables, meeting global energy demand will rely on traditional energy for some time – and we think it can outperform at times, especially when there are supply-demand mismatches.

Our bottom line

We monitor COP28 for signs of growth in transition-related investment themes. We see granular opportunities in public companies that produce climate resilience solutions across sectors. Solutions like early monitoring systems to predict floods or retrofitting buildings to better withstand extreme weather make the technology and industrial sectors stand out to us. And we think reforms could make it easier for private market players to fill the EM financing gap.

Market backdrop

Last week, the S&P 500 closed at its highest level this year after rising roughly 9% in November – the largest monthly gain in 16 months. The U.S. 10-year Treasury yield slid lower to near 4.30%, with its November drop of more than 50 basis points marking the largest monthly fall in 12 years. We expect further volatility for bonds in the near term as policy rates peak. We think long-term yields will rise again as investors demand more compensation for the risk of holding long-term bonds.

The U.S. payrolls report for November is in focus this week. We are looking for signs that job growth is slowing further as the post-pandemic normalization runs its course. Structural labor shortages as the U.S. population ages means the economy will only be able to sustain a fraction of recent job growth without stoking inflation again, in our view.

Read our past weekly market commentaries here.

Big calls

Our highest conviction views on tactical (6-12 month) and strategic (long-term) horizons, December 2023

Tactical granular views

Six to 12-month tactical views on selected assets vs. broad global asset classes by level of conviction, December 2023

Our approach is to first determine asset allocations based on our macro outlook – and what’s in the price. The table below reflects this. It leaves aside the opportunity for alpha, or the potential to generate above-benchmark returns. The new regime is not conducive to static exposures to broad asset classes, in our view, but it is creating more space for alpha. For example, the alpha opportunity in highly efficient DM equities markets historically has been low. That’s no longer the case, we think, thanks to greater volatility, macro uncertainty and dispersion of returns. The new regime puts a premium on insights and skill, in our view.