Tag: Federal Reserve

2017 Q1 letter: Renewable energy in the Trump era

2017 Q1 letter: Renewable energy in the Trump era

Dear Friends,

The first quarter of 2017 was full of eventful news for markets. We saw a Fed rate hike, record low unemployment rates, all time highs for US equity markets and a new administration sworn in, with Republicans now in full control of Congress. In our view, this likely marks an inflection point for the current business cycle and market levels.

Since the election, we have received several queries from our socially responsible investors about the fate of environmental and climate change regulation under the Trump administration. We understand and share many of their concerns. We hasten to add, however, that infrastructure spending and projects are usually undertaken with long time frames in mind. Enterprises making decisions about what kind of power plants to build will consider the costs over a long term. They are well aware that the current administration and its policies are not set in stone.

We do not expect a raft of coal plants to be built over the next four years — in fact, 2017 has seen an acceleration of the closure of several legacy coal plants. Large plants typically take 3-5 years to build and operators have to factor in the possibility that they will face a changed regulatory environment just as the plants come online. Natural gas prices are likely to play a much larger role in determining what resource mix generates our electricity. The cost of utility scale renewable solar power continues to fall, and though it is not yet competitive with cheap gas, it is not far off either. The IEA estimated the average capital costs of photovoltaic solar plants under construction to be 35-45% higher than natural gas plants per unit of energy produced. An array of tax credits make solar competitive with gas. though the precise economics are driven by regional factors and weather. Wind and hydroelectric power are already competitive with natural gas.

At the risk of appearing sanguine, we think that technological advances, consumer preferences, and the economics of scale have brought us to the point where renewable energy will be competitive with conventional electricity generation going forward. Installed renewable capacity will continue to increase, with or without incentives. If fuel costs move higher, renewables will be become very attractive.

In our view, purchasing certain sectors based on the administration’s stated policy preferences is unlikely to lead to consistent gains. Our reasoning is based on the Trump administration’s penchant for changing direction at the drop of a hat, and secondly on the opposition to various aspects of their policy agenda from either side of the aisle in Congress. In the medium and long-term, valuations and the business cycle will determine investor success. Neither looks particularly fortuitous at the moment for risk assets (equities, or long-term/lower-quality bonds). We continue to recommend a defensive shift for clients based on these factors.

Regards,

Subir Grewal, CFA, CFP Louis Berger

10 themes for ’10

10 themes for ’10

  1. Who’s Hiring? We expect to see the US unemployment rate peak in 2010 at 11%.  While seeing a peak will certainly be an encouraging sign, we don’t believe this will be followed by a rapid economic recovery creating the millions of jobs necessary to lower the unemployment rate down to pre-recession levels (5%).
  2. I’m fine with fixed returns: The credit crisis of ‘08-‘09 saw many individual and institutional investors badly burned by overexposure to riskier assets like stocks, commodities and real estate.  While there has been a strong recovery in many risky assets over the past 10 months, we expect investors will continue to re-allocate towards less volatile investment classes, such as bonds, with a trend towards a classic 50% stock 50% bond allocation.
  3. Collecting from sovereigns: 2009 ended with warning signs emerging from Dubai and Greece that there is a potential for default or credit deterioration among sovereigns that have over-extended themselves.  We expect to see a number of credit downgrades for developed nations as their persistent deficits, long-term pension/health-care liabilities and weak growth come into focus.  2010 may well see a sovereign nation default on foreign-currency debt obligations.  We expect the US Dollar and US treasury credit to strengthen in any ensuing flight to safety.
  4. Reading tea leaves at the Fed: On December 16, 2008, in an effort to encourage banks to lend and provide liquidity for the financial markets, the Federal Reserve lowered interest rates to effectively 0%.  This rate held throughout the entirety of 2009.  We expect this run to end in 2010 with the Fed raising interest rates in 4th quarter of the year.  We expect the Fed to tighten rates to the 1-2% range and then pause for a few quarters.  This will likely result in the yield curve flattening since long term yields will not rise as quickly.  Unlike many other market commentators, we do not expect high inflation despite large increases in measured money supply.  A sharply lower velocity of money and reduced money-creation via private sector credit will dampen inflation.
  5. Pay me my money down: Continuing the trend from 2009, we believe paying down debt will remain the highest priority for US consumers as they attempt to get their financial houses in order.  This will disrupt a strong recovery in corporate profits, particularly retailers (which rely on consumer spending to drive growth), as some businesses will misjudge the new environment.  However, this is very good for the long term health of the US economy.
  6. A cold year for growth: We expect the US economy will see almost negligible growth in 2010.  Margins will continue to contract for US businesses and profit growth will remain slim. The expiration of stimulus programs and slim prospects for their renewal in a mid-term election year will reduce aggregate demand.  Cost cutting and efficiency measures will continue to be necessary to offset top-line deterioration.
  7. Arranged Marriages: With margins slimming, interest rates at historic lows, the unemployment rate in double digits and the US consumer cutting spending, we see corporations increasingly turning to mergers and acquisitions in order to grow market share, particularly in the cash rich tech and energy sectors.
  8. New kids on the block: Emerging markets proved to be more resilient to the global recession than developed economies.  We expect growth in emerging markets will continue to out-pace growth in developed economies.  But this growth will not be enough to offset the stagnation in developed economies or lead to a robust global recovery.
  9. Red alert: We believe there is continued risk for a massive correction in China.  We remain skeptical of the veracity of the economic data released by the government and don’t see how the white-hot level of growth can be sustained when China’s main trading partners (namely the US, Europe, Japan) continue to suffer from the effects of the global credit crisis.
  10. Fool’s gold: We believe certain commodities are poised for a sharp sell-off over the next year.  Highest on our list for a correction are gold (which only has value if others think it does) and oil (many Iraqi and South American fields coming online and low growth implies low energy use).