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Environmental Solutions Outlook

Outlook
10 January 2024

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Latest Environmental Solutions outlook. 

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2023 was clearly a challenging year for environmental equities. However, we are optimistic about 2024 for a number of reasons. The most significant headwind has been rising bond yields, and whilst we can't state categorically that we have seen the peak in bond yields in this cycle, we do think it is likely that policy rates have peaked and that the October highs in bond yields also represent a peak for now. In any event we can assert with some confidence that the worst is behind us, given that US 10-year yields have risen from 0.5% in the summer of 2020 to 5% in October 2023. Even if bond yields may have temporarily overshot on the downside, the general backdrop on rates and yields is more benign, which is positive for equities in general, and particularly for valuations of Growth stocks in the environmental universe. We also believe that stable yields could help reverse the marked underperformance of small- and mid-caps versus large- and mega-caps, which we have already started to see.

Similarly, looking at the economic cycle, while the macro backdrop remains challenging in certain parts of the world and the outlook uncertain, the downturn in Europe, where the exposure of the fund is greatest, is well advanced. As a result, earnings expectations have already recalibrated to a lower level to factor in the weak macro backdrop. Moreover, many valuations of cyclical stocks are at trough levels, with depressed multiples on trough earnings offering some very compelling medium-term opportunities in several portfolio holdings.

As we have alluded to in other publications, it is not just traditional cyclicals that have seen negative earnings cycles. For example, there are many ingredients names in our universe that play to environmental themes such as food waste. Typically the consumer ingredients sector displays relatively low sensitivity to the economic cycle as its core customer base is consumer staples companies, where end demand tends to be reasonably stable. However, over the last 12-18 months the sector has seen a significant negative inventory cycle. In the aftermath of the pandemic, businesses looked to build buffer stocks amid challenged supply chains, but the subsequent combination of a slowdown in demand and elevated inventories has led to very substantial destocking. Ingredients companies have therefore seen volume declines that are far worse than previous cycles. Again however, this destocking has already been happening for over a year now, and has therefore largely played out.

So the significant headwinds that environmental equities have faced are starting to ease, and in some cases are turning into tailwinds. This is coming at a time when valuations in the majority of our universe  have fallen materially to very compelling levels. Specifically we track the upside to price targets across the portfolio and even after the recent rally, the upside to our average and median price targets remains very significant and is not far from all-time highs, and importantly these price targets have incorporated a permanently higher cost of capital and tough macro backdrop.

Important Information:

Nothing in this document constitutes or should be treated as investment advice or an offer to buy or sell any security or other investment. TT is authorised and regulated in the United Kingdom by the Financial Conduct Authority (FCA).

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