For much of this year, markets have been driven by factors rather than fundamentals, with investors heavily influenced by rising inflation and, as a result, rising interest rates. This benefited cheaper, cyclical areas of the market, but was detrimental to many sustainability-focused companies that have more durable earnings growth less reliant on the macro environment (by virtue of their provision of goods or services that fulfil an essential need).
But we believe this could be about to change. There are signs that inflation may have peaked, although in most markets consumer price inflation (CPI) is still higher than what central banks would be comfortable with. As such, we are not yet out of the woods and we expect interest rates will peak in 2023 at a higher level than investors previously envisioned, before declining. This is important because stocks prices have historically adjusted 12-18 months ahead of interest rates, which could provide a boost for more sustainable stocks, especially as recession looms and earnings growth becomes increasingly scarce.
With the price of sustainability near its trough, as illustrated below, the Federated Hermes Global Equity team believes that this could present an excellent opportunity for long-term investors to buy companies that have high expected earnings growth and deliver positive outcomes for society.
Figure 1: Price of sustainability vs. US 10-year yield
Source: Federated Hermes, as at 1 November 2022.
Improvers of today, leaders of tomorrow
That said, it will be important to adopt a broad view. In 2014, the team’s pioneering research was able to correlate ESG with performance. This highlighted the importance of identifying not just the current leaders in the ESG space, but the ‘leaders of tomorrow’. The same is true for sustainability.
For many investors, the most tangible opportunity surrounds companies that have strategies to grow the sustainable areas of their business, but at Federated Hermes we believe there are also very attractive long-term opportunities to invest in companies with transition potential too. This is why we have built improvement, trend, and long-term resilience into our sustainability assessment.
To find out more about our Global Equity ESG strategy, please visit our capability page.
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