Green bill or green bubble?

This week’s debate turned into a brawl between Biden and Trump, giving hardly any clarity on important topics for the United States and the rest of the world. The outcome of the US election still represents one of the key uncertainties for among others the European stock markets. While listed in Europe, many of the European companies are active in the US. In fact, 23% of pan-European sales are generated in the US (5-50% range on a per sector level) and, therefore, will have a high exposure to changes in US regulations and policies.

Given the diametrically opposed climate policy in the candidate’s campaigns, how would a Biden (or Trump) victory shape the performance of the European sustainable stocks in our universe?
In this article, we will focus on the impact of a Biden victory with enough of a majority to push through his proposed “Green Bill” legislative changes.

STRONG ESG MOMENTUM LEADS POLICY CHANGE

Before we move to the evaluation of Biden’s Green bill itself, it is important to recognise that not only does this policy entice the younger generation to vote Democrat, it also allows Biden to capitalise on the growing global ESG momentum to advance the Democrat agenda in America.

Globally, an increasing number of companies (and especially in Europe) have been embracing the ESG criteria and incorporating sustainability into their strategies, business models and management compensation metrics. Even perceived climate dinosaurs such as BP have jumped on the bandwagon and announced ambitious new strategies to deliver on their net-zero ambitions by 2025.

Already, public opinion and governmental focus has shifted, resulting in a Green Recovery plan in Europe. Furthermore, the Chinese government has announced its ambition to being climate neutral by 2050 and we now see the potential in the case of a Biden win, for the American focus to also shift towards a more environmentally conscious model. This shift is unprecedented, with climate becoming one of the key issues for global security and foreign policy.

There are several factors that accommodate the transition to a positive mindset regarding sustainable stocks, for example: the drastic fall in clean energy costs, the rapid progress of clean technologies, low interest rates and the impact of the COVID-19 pandemic.

On the investor side, sentiment towards companies with a sustainable focus have become far more positive, resulting in circa USD100 billion inflow to global ESG funds YTD almost half of the cumulative inflows over the last 20 years according to BoAML analysis.

Global Weekly ESG Flows update

^{Source: EPFR Global, BofA European Equity Quant Strategy}

YTD performance of most overweight ESG stocks vs most underweight ESG stocks in Europe

^{Source: BofA European Equity Quant Strategy; Factset Ownership}

Whilst demand is increasing, the amount of available sustainable stocks – even in Europe - is still limited, which has led to a decoupling of performance of sustainable stocks from the broader market and their stretched valuations. The MSCI ESG leaders index has outperformed the broader MSCI Europe index by 4.8% YTD and by 8.4% since the end of 2017. The Top 50 most overweight ESG stocks vs the Bottom 50 most underweight index tracked by BofA generated close to a 20% outperformance YTD. Going forward into the elections, we should ask ourselves the questions whether the current premia for sustainable stocks is maintainable or will there be a prolonged sell-off?; and what are the additional drivers in the US that can act as a support for the European companies beyond the impact of the European Recovery fund?

The general consensus is that whilst ESG stocks will benefit from a Biden win, the broader market will be negatively impacted due to his “Green Bill” and the need for funding this via tax increases. On the flip side, a Trump win would likely be favoured by the broader market but have a negative effect on ESG premia, leading to a sell-off of sustainable stocks.

If indeed we witness a burst of the ESG bubble and a strong contraction of the ESG premia, it will provide a great opportunity for longer term investors (including ACTIAM Duurzaam Europees Aandelenfonds) that feel that the current ESG trends are irreversible and that companies with high sustainability scores will be the winners in the long term, generating above average shareholders returns.

THE PROPOSED GREEN PLAN AND TAX RATE IMPLICATIONS ARE THE KEY

The infrastructure bill

Passing of their respective Infrastructure bills will be the key for both candidates as a path to overcoming the COVID-19 crisis and job creation. Biden bets on the sustainable infrastructure developments and transition to green energy, while Trump prefers to put more focus on existing infrastructure.

Below you can see a comparison of Biden and Trump’s proposals. Biden’s proposals are much broader, detailed and “green” oriented, in line with his ambition to achieve a net-zero emissions economy by 2050.

Other Biden policy plans that can impact the European sustainable names

• Taxes: Taxes: On the flip side of the Biden’s plan is the necessity to pair the green investments with tax increases for corporations (from 21% to 28%) and rich Americans (from 37% to 39.6%). We believe that only a 4% corporate rate hike is realistic, leaving a gap in financing. Trump advocates for a further decrease in individual and corporate rates, which would bolster the broader stock market sentiment.
• Biden has reaffirmed that he wants to re-join the Paris Climate Agreement.
• Both candidates have stressed the need for a more firm approach to US-China relations, so we don’t expect much changes on this front, except for an absence of sharp market reactions on Trump tweets.
• Biden criticizes Trump’s tariff wars as bad for US consumers and farmers. Therefore, we can expect a softening or rolling back of some tariffs. As a reminder, the current tariffs impact exports on certain categories of products from China, Mexico, Japan, and Europe (cars).
• Stronger action is expected on competition policy, antitrust enforcement and privacy policy, as well as healthcare reform and drug pricing reviews.

WILL EUROPE BENEFIT?

From the sector perspective, the European industrials would benefit the most from a Biden win. While industrials in total generate only 26% of revenues in the US, some high ESG names have the right thematic exposure to the proposed green construction and infrastructure themes, including grid upgrades, EV and telecom infrastructure upgrades, building renovations and equipment for energy transition.

European utilities sector could benefit from its experience with renewables, especially offshore wind, as the European companies were early adopters of the technology. Therefore, the offshore wind generation theme could be played by the European utilities Orsted (market leader with 90% of power generation through renewables), RWE and Iberdrola due to their existing experience with offshore wind farms. If the US tenders start moving forward, these names will definitely participate.

2020-2029 offshore wind projections

^{Source: Wood Mackenzie, as of 12.05.20}

2019 wind turbine market installed capacity

^{Source: Evwind, News menu, Uncategorized, Wind Energy}

The European Building Materials industry has circa 35% EBITDA exposure to the US Infrastructure and construction markets. For CRH this number is close to 70% EBITDA and an uptick for surface infrastructure could lead to new business opportunities.

Sectors with a net negative impact from Biden’s policies would include:

• Energy: A realistic probability of a carbon tax and/or a clean energy standard, new restrictions on fracking and energy exports, stringent regulation of emissions changes and changes to federal land leasing/permitting policies – are the likely consequences of a Biden win for the US oriented oil & gas companies.
• If adopted, the proposals will likely restrict the US’s future oil and gas production growth. BP, RDS, Equinor, Repsol and Total are exposed to the US shale and Gulf of Mexico. Their combined mid-term effect should be net negative, despite some support that might come from uplift in renewable activities.
• Tech sector: The European tech sector is home to a number of high ESG names. It will likely feel pressure from changes in regulation related to stronger action on competition policy, antitrust enforcement, privacy policy, cybersecurity, Section 230 reforms and a potential hike in corporate tax. Most of the European large cap names with high US direct and indirect exposure (through clients), as well as strong competitive position in America are likely to feel a negative impact.
• Pharma: The European pharmaceutical industry could feel some pressure from the renewed drug pricing scrutiny and higher corporate tax rates. The fear of a negative impact of the reforms weigh on the sentiment of most of EU pharma due to a high exposure to the US (more than 50% of revenues), especially Roche and Novo Nordisk.

^{Source: ACTIAM, Factset}

CONCLUSION

In conclusion, there will be a mixed bag for the markets no matter which candidate prevails, but in the case of a Biden presidency there will be a clear progress on the global climate agenda benefiting the companies in the ESG universe. To support the further valuations of “green” stocks, we will need to see his plans unfold and expand to reality. As an active investor, one needs to monitor closely all the relevant developments and continue being vocal on the ESG front through direct contact with the companies in the relevant universe.

Will there be extra upside coming from companies in transition with an extra leg of support in valuations coming from upgrades in growth profiles and EPS estimates? We certainly hope so. In the meantime, if the market experiences a sell-off in the ESG names, we can use it as a short-term investment opportunity to enter great stocks.