Relief and Volatility Ahead for U.S. Stocks

The eventual size of the Democratic Party’s fiscal policy legislation – for taxes and for spending – will likely impact the bond market as well as the policy landscape.----- Transcript -----Welcome to Thoughts on the Market. I'm Michael Zezas, Head of Public Policy Research and Municipal Strategy for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the intersection between US public policy and financial markets. It's Wednesday, September 29th at 1:00 p.m. in New York. It's shaping up to be one of the most consequential legislative weeks on record in the US. At stake is the size and fate of Democrats' fiscal policy ambitions, specifically their goals of a major tax increase to fund a substantial expansion of infrastructure spending and the social safety net. But intraparty disagreements on the content of these efforts have left investors wondering: what will the final package do to the U.S. fiscal outlook and, therefore, the trajectory for bond yields? Will the Democrats go big, keeping yields moving higher, or go small, potentially meaning the worst of the recent increase in bond yields is behind us? Our current thinking is that the Democrats eventually end up going big. Why? Because neither of the two legislative vehicles they're considering are possible without the other - they're linked. Moderates, particularly in the Senate, may be happy with approving the smaller bipartisan infrastructure framework, or BIF. But progressives don't appear content with just this achievement and continue to argue they'll withhold their votes on the BIF until the whole of the party endorses a specific plan for the bigger budget reconciliation bill. This de facto linking of the two bills may mean that Democrats' planned votes this week to pass the BIF gets delayed, but it keeps the party on track for what we think would be a combined increase in spending of over $3T over 10 years, adding upwards of $1T to the deficit over the first five years. That would help keep support under the economic recovery and the upward trajectory of bond yields over the medium term. It could also mean equity markets are choppy in the near term as they digest a meaningful incoming tax hike. But breaking that link and going small is something we have to consider too. If progressives give in and vote for the BIF without a dependable agreement on reconciliation, the moderates will be in the driver's seat on the rest of the negotiation - and already key moderate Democratic leaders have said they'd delay the timing and dilute the size of the reconciliation bill. In that case, we'd substantially mark down our expectations for the impact to deficits, as well as for the scope of tax hikes. For this outcome to become more likely, look for a public signal from the White House to persuade progressives to vote for the BIF by explicitly endorsing the strategy of voting on it before reconciliation is agreed to. We hope this can be a guide to track how the situation develops over the next few days. And we’ll of course be paying close attention and be back next week to size it all up again. Thanks for listening. If you enjoy the show, please share Thoughts on the Market with a friend or colleague or leave us a review on Apple Podcasts. It helps more people find the show.

30 Sep 20212min

With incoming global growth data missing consensus expectations, emerging markets equity earnings revisions could fall back into negative territory for the first time since May 2020.----- Transcript -----Welcome to Thoughts on the Market. I'm Jonathan Garner, Chief Asia and Emerging Markets Equity Strategist for Morgan Stanley Research. Along with my colleagues, bringing you their perspectives, today I'll be talking about a key recent development, which is the deterioration in the global growth outlook and what it means for Asia and EM equities. It's the 29th of September at 7:30 a.m. in Hong Kong. Incoming global growth data is starting to miss expectations by a wide margin. This appears to be mainly due to the impact of Delta-variant covid on consumer confidence, but also continued supply chain bottlenecks on the corporate sector. The Global Economic Surprise Index, i.e., the extent to which top-down global macro data beats or misses economists' expectations, has fallen in a straight line from a level of +90 in mid-June to -24 currently. It was last this low at the end of March 2020, at the beginning of the global impact of the pandemic, and before that in the second quarter of 2018, at the start of US-China tariff hikes and the imposition of non-tariff barriers to trade. So in short, there's been a sudden downward lurch relative to expectations for global macro in relation to the narrative from consensus of a continued strong recovery, broadening out by geography, and entering a virtuous circle of rising consumption and investment. Global equity markets have wobbled recently but are still trading close to their all-time highs set in early September. We think the key to understanding what happens next is to understand the relationship between Economic Surprise data and earnings revisions. We’ve found that changes in the Global Economic Surprise index tend to have a good leading relationship for how bottom-up analyst earnings revisions evolve three months later. And that, in turn drives market performance. And this matters because the covid recession and recovery have already witnessed exceptionally sharp movements, both in economic data - relative to consensus - and earnings estimate revisions. Indeed, they've been more extreme even than the volatility that we saw at the time of the Global Financial Crisis. So, at this level of -24 on economic surprise, our analysis suggests 12-month forward EPS expectations will likely decline by around 150bps over the next three months. That may not sound like much, but it compares with a current positive QoQ upward revision of 530bps and a peak QoQ revision of 1100bps in May of this year. Within our coverage, some markets have already gone through the transition adjustment to slower expected earnings revisions - most notably China, where we remain cautious. Our analysis finds that strong performance and strong revisions are positively correlated and vice versa for weak performance and poor revisions. Japan, Russia and South Africa are the standouts recently for positive revisions, and they may show some resilience to the deteriorating global situation. China, Indonesia, Malaysia and Thailand have had the worst revisions and generally poor performance; but China has also been underperforming due to investors assigning a lower valuation to the market due to this year's regulatory reset. Overall, we continue to prefer Japan to EM and China. Thanks for listening. If you enjoy the show, please leave us a review on Apple Podcasts and share Thoughts on the Market with a friend or colleague today.

29 Sep 20213min

Real interest rates are on the rise in Europe and the US and central banks are responding. This may impact currency markets headed into the fall. Matt Hornbach, Global Head of Macro Strategy, explains.-----Transcript -----Welcome to Thoughts on the Market. I'm Matt Hornbach, Global Head of Macro Strategy for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about global macro trends and how investors can interpret these trends for rates and currency markets. It's Tuesday, September 28th, at 12:30p.m. in New York. Just like clockwork, markets have become much more interesting and volatile after Labor Day in the U.S. Investors have been confronted with several issues that have collided in a big bang after what had been a relatively quiet summer. And central bank reactions have been a key part of the story going into the fall. To start, supply disruptions in commodity markets have led to inflation fears that have manifested themselves in higher market prices for inflation protection, mostly in Europe and the U.K. In response, the Bank of England has expressed more concern over the inflation outlook, since inflation is having a negative impact on the region's growth outlook. This combination of factors has caused real interest rates in Europe and the UK to remain extremely low and has also put downward pressure on the value of the British pound and the euro. Meanwhile, the U.S. economy has been more insulated from the commodity price shock, and inflation protection in the U.S. was already fully valued. In other words, worries about inflation in the U.S. began to build last year and, as a result, investors had already prepared themselves for the elevated inflation prints we're experiencing in the U.S. today. This means that real interest rates in the U.S. are left marching to the beat of other drummers. In particular, real interest rates in the U.S. have begun to respond to Federal Reserve monetary policy machinations. Last week, the Fed signaled that tapering its asset purchases could begin near term. That means the Fed will start purchasing less Treasury and agency mortgage-backed securities, leading to a decline in the amount of monetary accommodation the Fed has been providing. The question is, is this tapering akin to tightening policy? Participants on the Federal Open Market Committee would have you believe that tapering isn't the same thing as tightening policy. And technically they would be correct. When the Fed purchases assets in the open market such that its balance sheet grows, it is easing monetary policy. It's a different form of cutting interest rates. When the Fed's balance sheet no longer grows because it has stopped purchasing assets on a net basis, it is no longer easing monetary policy. In the transition between these two states, the Fed's balance sheet continues to grow, but at a slower rate than before. In this way, the process of tapering is akin to easing policy, but by less and less each month. But, and this is a big 'but', the process of tapering is the first step towards the process of tightening. Without the Fed tapering its asset purchases and slowing the growth of its balance sheet, rate hikes wouldn't appear on the radar screens of investors. So, the prospect of tapering this year has shown a spotlight on the prospect of rate hikes next year. And that has driven real interest rates higher in the U.S. So, what happens now? As long as real interest rates in the U.S. rise gradually, as they have done so far this year, the overall level of interest rates in the U.S., as you can see in the Treasury market, should also rise gradually. And if U.S. interest rates rise relative to those in Europe, which already began in August and we think will continue through the balance of the year, then the value of the U.S. dollar should appreciate relative to the euro. Thanks for listening. If you enjoy Thoughts on the Market, please take a moment to rate and review us on the Apple Podcasts app. It helps more people to find the show.

28 Sep 20213min

Our analyst’s equity positioning models have held up well and we continue to rely on an understanding of historical cycles as we move through this mid-cycle transition. Chief Investment Officer Mike Wilson explains.----- Transcript -----Welcome to Thoughts on the Market. I'm Mike Wilson, Chief Investment Officer and Chief U.S. Equity Strategist for Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, I'll be talking about the latest trends in the financial marketplace. It's Monday, September 27th, at 11:30a.m. in New York. So let's get after it. Our equity strategy process has several key components. Most importantly, we focus on the fundamentals of growth and valuation to determine whether the overall market is attractive and which sectors and stocks look the best. The rate of change on growth is more important than the absolute level, and we use a market-based equity risk premium framework that works well as long as you apply the correct regime when using it. In that regard, we're an avid student of market cycles and believe historical analogs can be helpful. For example, the mid-cycle transition narrative that has worked so well this year is derived directly from our study of historical, economic and market cycles. The final component we spend a lot of time studying is price. This is known as technical analysis. Markets aren't always efficient, but we believe they are often very good leading indicators for the fundamentals - the ultimate driver of value. This is especially true if one looks at the internal movements and relative strength of individual securities. In short, we find these internals to be much more helpful than simply looking at the major averages. This year, we think the process has lived up to its promise, with the price action lining up nicely with the fundamental backdrop. More specifically, the large cap quality leadership since March is signaling what we believe is about to happen - decelerating growth and tightening financial conditions. The question for investors at this point is whether the price action has fully discounted those outcomes already, or not. Speaking of price, equity markets sold off sharply last Monday on concerns about a large Chinese property developer bankruptcy. While our house view is that it likely won't lead to a major financial contagion like the Global Financial Crisis a decade ago, it will probably weigh on China growth for the next few quarters. This means that the growth deceleration we were already expecting could be a bit worse. The other reason equity markets were soft early last week had to do with concern about the Fed articulating its plan to taper asset purchases later this year, and perhaps even moving up the timing of rate hikes. On that score, the Fed did not disappoint, as they essentially told us to expect the taper to begin in December. The surprise was the speed in which they expect to be done tapering - by mid 2022. This is about a quarter sooner than the market had been anticipating and increases the odds for a rate hike in the second half of '22. After the Fed meeting on Wednesday, equity markets rallied as bonds sold off sharply. Real 10-year yields were up 11bps in two days and are now up 31bps in just eight weeks. That's a meaningful tightening of financial conditions and it should weigh on asset price valuations, including equities. It also has big implications for what should work at the sector and style level. In short, higher real rates should mean lower equity prices. Secondarily, it may also mean value over growth and small caps over Nasdaq, even as the overall equity market goes lower. This would mean a doubly difficult investment environment, given how most are positioned. For the past month, our strategy has been to favor a barbell of defensive quality sectors like healthcare and staples, with financials. The defensive stocks should hold up better as earnings revisions start to come under pressure from decelerating growth and higher costs, while financials can benefit from the higher interest rate environment. Last week, this barbell outperformed the broader index. On the other side of the ledger is consumer discretionary stocks, which remain vulnerable to a payback in demand from last year's over consumption. Within that bucket, we still favor services over goods where there remains some pent-up demand in our view. Thanks for listening. If you enjoy the show, please leave us a review on Apple Podcasts and share Thoughts on the Market with a friend or colleague today.

27 Sep 20213min

This week, the Fed hinted that a taper announcement in November could be in store, adding one more wrinkle into events that investors will need to navigate this fall.----- Transcript -----Welcome to Thoughts on the Market. I'm Andrew Sheets, Chief Cross-Asset Strategist for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about trends across the global investment landscape and how we put those ideas together. It's Friday, September 24th, at 2:00 p.m. in London. The Federal Reserve, or the Fed, probably receives more attention than any other institution in today's market. At one level, that's easy to explain; it's the central bank for the world's largest economy and reserve currency, and just so happens to be buying $120B of bonds every month. At another level, though, it feels a little excessive. Investors have woken up to the exact same interest rates and purchases from the Fed every day for more than a year. And if you look at global stock markets since May of last year, they've basically just risen in lockstep with the overall level of earnings. Still, the Fed matters, and this week it made some consequential announcements. It suggested strongly that it would begin to slow, or taper, those bond purchases, and do so soon, ending them completely by the middle of next year. Its members increased their expectation for how much they thought interest rates would rise in 2023 and 2024. All of this was driven by ongoing improvement in the economy and signs that inflationary pressures were finally building. One could be forgiven for thinking that the market would look at fewer purchases by the central bank, and higher interest rates, and think this was a bad thing. But markets are fickle, especially over short horizons, and stocks rose sharply both the day of and the day after the Fed's announcement. Interest rates also rose, following the lead of the Fed's shifting projections. Of those two reactions, we find those of the bond market much easier to justify. What really matters, however, is not what these changes mean for the market over the next two days, but over the next two years. And here, three things stand out. First, the Fed hasn't completely left the party, so to speak, but it is sliding towards the exit. Bond purchases by the Fed should still be with us for nine more months, but the signs of a different phase of central bank policy have clearly begun. Second, this next phase, the so-called taper, is likely to be a major focus for investors. The last time the market focused on slowing Fed purchases in 2013 and 2014, equity markets generally climbed. But yields rose and gold prices sank. We see a similar impact for both bonds and gold this time around, with our interest rate strategists particularly focused on how fast the Fed will raise rates - a pace that they think the market is still underestimating. Third, the Fed's actions are divergent from other central banks. While the Fed is shuffling towards the proverbial exit, the Bank of Japan and European Central Bank are much farther away and haven't even seemed to start moving. We think this results in a stronger dollar, relative to the Euro and the Yen, and will lead to better stock market performance in the latter regions. A shifting Fed is just one of several events markets need to navigate over the next several weeks. We think these events remain challenging and investors will get a better opportunity to be more aggressive later in the year. Thanks for listening. Subscribe to Thoughts on the Market on Apple Podcasts or wherever you listen and leave us a review. We'd love to hear from you.

24 Sep 20213min

Why two D.C. policy items—the bipartisan infrastructure framework and debt ceiling deliberations—could add one more complication for equities markets.----- Transcript -----Welcome to Thoughts on the Market. I'm Michael Zezas, Head of Public Policy Research and Municipal Strategy for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the intersection between US public policy and financial markets. It's Thursday, September 23rd, at 10:30 a.m. in New York. Markets this week have had a lot to focus on - from the Fed's policy decisions to fresh concerns about global growth. But expect that focus to shift next week, or possibly sooner, to events in Washington, D.C. In particular, watch out for two events that could catalyze some market volatility. First, keep an eye on the planned vote on the bipartisan infrastructure framework, or BIF for short. This vote, which could come as soon as Monday, is a key test for whether or not the Democrats will be able to 'go big' on fiscal policy. That's because the BIF - which would add about $550B of new spending over 10 years to the budget - was supposed to be paired with a bigger, budget reconciliation bill that could reach as high as $3.5T over 10 years. The linking of the two was meant to align the interests of moderate and progressive Democrats in Congress. But that reconciliation bill isn't ready yet for a vote alongside the BIF. So, if the smaller bill gets approved, the moderates will have gotten most of what they want and could be more demanding on the bigger bill, either stalling it or shrinking its size. At the moment, it's far from clear that the BIF can get enough votes to pass on its own, meaning the 'all or nothing' dynamic on fiscal policy remains intact. But if the BIF succeeds, that would suggest a smaller fiscal package, smaller deficit impact, and a key challenge to our view that bond yields will rise meaningfully into year end. We'd also keep a close eye on the deliberations around raising the debt ceiling and avoiding a government shutdown. While the 'x' date - the day by which the debt ceiling needs to be raised or suspended in order to avoid a payment default on Treasuries - is likely the more impactful deadline - which our economists expect will be late October, early November - markets may be more focused on September 30th, the date by which Congress must authorize a continuing resolution for new spending, or else the government shuts down. While we ultimately expect these issues to be resolved in a manner that doesn't materially impact the US growth outlook, the path to resolution on these issues likely requires escalated uncertainty in the near term. Since Democrats have paired the continuing resolution with a debt ceiling hike, which Republicans flatly oppose on the idea that Democrats should go it alone using reconciliation, there's no clear path forward at the moment. For example, the House just passed a continuing resolution, which the Senate is unlikely to be able to carry forward given insufficient Republican support. So, headlines around a government shutdown should pick up, and with it the takes that the situation increases the risk that the debt ceiling can't be raised in a timely manner. Taken together, these two concerns could weigh on the equity market, where our colleagues in cross-asset strategy have suggested performance could be sluggish in the near term as investors grapple with the transition from early to mid economic cycle dynamics. The shift from clear D.C. stimulus support to D.C. uncertainty could be one part of that shift. Thanks for listening. If you enjoy the show, please share Thoughts on the Market with a friend or colleague, or leave us a review on Apple Podcasts. It helps more people find the show.

23 Sep 20213min

On this special episode, we address key questions around struggles in China's property sector, as well as any potential spillover into the broader economy.----- Transcript -----Chetan Ahya Welcome to Thoughts on the Market, I'm Chetan Ahya, Chief Asia Economist for Morgan Stanley,Robin Xing and I'm Robin Zing Morgan Stanley's Chief China Economist.Chetan Ahya And on this special edition of the podcast we'll be diving into the path forward for China's economy amid challenges in the property sector. It's Wednesday, September 22nd, at 7:30 a.m. in Hong Kong.Chetan Ahya So, Robin, as many listeners likely read earlier this week, China's property market is the subject of a lot of market and media focus right now. And near-term funding pressures for some of China's property developers have led to volatility as markets weigh concerns on any ripple effect into China's economy or even the global economy. To put funding pressures in context, in dollar terms, cumulative default in China's high-yield property names this year are already higher than that combined between 2009 and 2020. Robin, I want to get into your base case for China's economy as policymakers manage the property sector outcome. But to understand the backdrop for listeners, maybe it's worthwhile to take a step back to understand China's regulatory reset and the impact it's had on the housing market.Robin Xing So what we call China's regulatory reset is China's ongoing shift in governance priorities, which policymakers drafted last year. And it covers a number of areas, including technology, education, carbon emission, but also property developers in an effort to address the financial stability risks. So the property related financing has actually been tightening since summer 2020. You know, first with new financing rules for real estate companies--what's called the 'three red lines'--which put a leverage cap on developers, then a cap on property, long exposure for banks, and lately, very strict mortgage approval for homebuyers. In this environment, highly leveraged developers are more prone to refinancing risks. And now the question is, will there be more credit events to come? Going forward, tighter financing conditions may stay for developers, which could increase the risk of credit events.Robin Xing So, Chetan, you have been a close watcher for China's debt and the deleveraging dynamics since 2015. First, with its industrial sectors, then it's local government. Then we fast forward to today's housing market. Now, just to gauge how much deleveraging developers still have to undergo, how are we tracking on the three red lines as laid out by regulators? As I recall, developers are required to attain the 'green category,' meeting all three requirements by end of the first half 2023.Chetan Ahya Yeah, thanks, Robin. So, look, I think, first of all, just to appreciate the way China manages its debt challenges is it ensures that the process is taken up in an organized manner and that there are no uncontrolled defaults, which can have ramifications on the financial system as well as overall financial conditions. And property sector is no different. And on that front, our property analyst has been highlighting that out of 26 developers that we cover, only one developer still fails to meet all the three red lines and nine developers have already passed two of those red lines. The remaining 16 developers have already met all the three requirements, and most developers do target to attain green category by the end of next year. Currently, the total debt exposure of the property developers in China is around 18.4trn RMB, which is similar to the annual contract sales or annual sales of these companies, so the deleveraging pressure when you look at it in the context of the level of debt relative to sales, it does seem to be manageable for usChetan Ahya Having said that, Robin, and when you think about the importance of the property sector to the economy, it's quite a significant sector. Property and property related sectors account for 15% of GDP. So, if there is a problem and a developer faces a challenge in meeting its debt obligations, do you think that China can manage the ramifications?Robin Xing Yes, we do think regulators already have a playbook based on past default cases, which included the property developers. That said, the timing of deployment is what may matter most. Potentially Beijing's first goal would be to maintain normal operations of construction projects so default happens at the holding company level and not at the project level, which could reduce spill over to the physical property market. The second goal would be to go for voluntary debt restructuring and avoid a liquidation scenario which could substantially increase the recovery rate, though both of these actions would require coordination across authorities, creditors, and the company in this scenario. We expect the property sales and the investment in China to slow and the new starts would remain weak for the remainder of the year. However, it would not be a very fast and sharp deterioration because current inventory levels for the housing market are low, with around eight months for the major tier-one/tier-two cities. So, it's much lower than previous downturns. So, the overhang on housing new starts should be much smaller. All in all, in this swift intervention and policy easing scenario, we see China's GDP to rebound modestly from the 4.7% in the third quarter in two-year CAGR terms to slightly above 5% in the fourth quarter.Chetan Ahya So, Robin, when you think of the developments in the property market right now, in the context of the fact that the government has also been taking additional regulatory measures which have been weighing on the private business sentiment, do you think that the government can take up easing measures to ensure that this does not have a meaningful impact on the growth outlook?Robin Xing Yes, your concerns are very legitimate. Given the importance of the property sector to China's economy, Beijing may decide to take action sooner rather than later in order to support the economy. In our base case, we are near an inflection point of policy easing. That would be led by faster fiscal spending to support infrastructure investment from September to December, complemented by another 50 basis point reserve requirement ratio cut by the People's Bank of China probably in mid to late October. We also see some easing in mortgage quotas in the fourth quarter. This altogether should drive a modest rebound in broad credit growth in the fourth quarter, marking the end of a 10-month credit growth downturn. What's more, this momentum can be amplified in early next year when the fiscal spending and the credit quota could be front loaded.Chetan Ahya So, Robin, if I were to summarize, essentially what we are talking about is two sets of policy actions to be taken up by the government. First, to ensure that the debt restructuring is taken up in an organized and timely manner. And second is that to the extent to which there will be some negative impact on business sentiment, we're expecting the government to implement policy easing measures.Chetan Ahya However, if the government were to delay these supportive measures, what will be the implications on your growth forecast?Robin Xing That's certainly a scenario we hope to avoid. So basically, should policy makers fail to take actions in time to manage this restructuring and contain its spillover effect, we could see a rise in liquidity pressures on many more developers as banks cut credit lines and home buyer sentiment cools down. In this case, the fourth quarter growth could fall below 4%, far lower than the annual growth target, which was 6% for this year and probably around 5.5% for next year. In short, such delayed action, more spillover scenario would likely warrant a much bigger stimulus in earlier 2022 to meet the growth target to stabilize the job market.Chetan Ahya Robin, thank you for taking the time.Robin Xing It's been great speaking with you.Chetan Ahya And thanks for listening. If you enjoy Thoughts on the Market, please leave us a review on Apple Podcasts and share the podcast with a friend or a colleague today.

22 Sep 20218min

This Climate Week, we preview environmental policy proposals within the $3.5 Trillion Budget Reconciliation Bill. What will it mean for investors and the response to climate change?----- Transcript -----Jessica Alsford Welcome to Thoughts on the Market. I'm Jessica Alsford, global head of Sustainability Research team at Morgan Stanley.Stephen Byrd And I'm Stephen Byrd, head of Morgan Stanley's North American Research for the Power & Utilities and Clean Energy Industries.Jessica Alsford And on this special Climate Week episode, we'll be talking about some landmark climate and environmental policy proposals in the U.S. and the future of energy. It's Tuesday, September the 21st, at 2:00 p.m. in London.Stephen Byrd And 9:00 a.m. in New York.Jessica Alsford So, Stephen, earlier this month, the U.S. House of Representatives released a draft of some climate and environmental policies as part of its $3.5T budget reconciliation package. I want to dig into your takeaways, but first of all, maybe you could walk us through some of the headline proposals.Stephen Byrd Absolutely, Jessica. This is one of the most exciting pieces of proposed legislation we've seen in the United States, at least with respect to clean energy. And I'll just highlight a handful of very important provisions that are currently in the draft. First, there's a very bold, clean electricity performance program or CEPP that would provide significant incentives for utilities and other loads of green entities to increase their renewables every year. Secondly, there would be a new tax credit for energy storage and biofuels. Third, a major extension of tax credits for wind, solar, fuel cells and carbon capture and payment levels are higher in many cases. Fourth, significant incentives for domestic manufacturing of clean energy equipment. Fifth, what we would call direct pay for tax credits, which basically provides owners with the immediate cash benefit of tax losses. That provides enhanced financing efficiency and better cash flow. Six, a nuclear power production tax credit. Seven, a major clean hydrogen tax credit. And lastly, number eight, significant capital to reduce the risk of wildfires. So very significant. Covers a lot of different areas within the entire clean energy spectrum.Jessica Alsford Absolutely. There's a huge amount in there. I guess maybe just to pick out some key points, are there any particular technologies that you think could really incrementally benefit from this bill versus what the status quo is at the moment?Stephen Byrd Yes, there's definitely a handful of technologies that would benefit in a very significant way. I would say. Probably first on my list is green hydrogen. The proposed payment is three dollars a kilogram - this is the subsidy amount - which is a very large amount of subsidy, in our view, would really kick start growth of green hydrogen across the board in the United States. We did a deep dive into the economics of producing green hydrogen over time, and we do think this amount of subsidy would be a huge boost to the growth of green hydrogen, would defray much of the cost producing green hydrogen. So, any company involved in green hydrogen, I think would see a significant benefit here.Stephen Byrd Another, nuclear power, not new nuclear projects, but existing nuclear assets would receive significant financial support. That is going to serve essentially as a stabilizing force to ensure that we don't see additional shutdowns of nuclear power plants. So that's a big win. I'd say, also, energy storage gets a tax credit for the first time and demand for energy storage is already very high in the United States, but a tax credit that would essentially line up with wind and solar would, we think, provide further incentive for more rapid growth of energy storage. So those are a couple that I would highlight as significant beneficiaries from this proposed legislation.Jessica Alsford Now, this text is the initial draft and say we should probably expect to see changes. What are you hearing in terms of these proposals and how much could actually make it into a final bill?Stephen Byrd This is really interesting. We do think that much of this language will survive. There is one provision, a very important one, that has received pushback. That's the first on the list that I mentioned. This is the Clean Electricity Performance Program or CEPP. Senator Joe Manchin, who's quite important, as well as a few others, have pointed out concerns with the current drafting of the language, a few companies have also expressed concerns. So, we could see changes there, maybe even elimination of that provision. However, many of the other elements of this package do appear to have quite a bit of support. So solar, wind, energy storage, even green hydrogen, we think has a significant amount of support. So, we do think much of this will survive. The one that's been singled out recently is that CEPP.Jessica Alsford Now also on climate, the Biden administration and the EU have actually jointly announced that Global Methane Pledge, which is aiming to reduce methane emissions by at least 30% from 2020 to 2030. Now, what are your thoughts on this? How significant is it for the utility sector?Stephen Byrd Yes, Jessica, I think this cuts both ways in terms of the methane emissions goal. I think on the positive side, I think many investors, especially ESG investors, would like to see significant commitments to reducing methane emissions. And, you know, we can see why certainly methane is so much more harmful from a greenhouse gas perspective relative to CO2. So, I think many investors will applaud this. The big concern will be the cost and the customer bill impact. Right now, given the increase in natural gas prices in the United States and really globally, there is already a concern around the increase in customer bills for those customers who buy natural gas. So, this would increase the cost.Stephen Byrd That said, utilities have a long history of being able to recover these costs. So, on the positive side, this could result in better growth in earnings per share, as well as improved ESG perception and reality in the sense of lower emissions. The key question is how are we going to manage the cost of this? And right now, that's causing quite a bit of investor concern. So, it's a bit of a mixed message. I'd say in the long term, though, a positive from a better growth perspective and lower emissions perspective.Jessica Alsford And finally, from me in this context of the U.S. really increasing its focus on halting climate change, what are the opportunities that you think investors should be looking at?Stephen Byrd So we do see several business models and technologies that should benefit significantly from this policy shift. I would say developers of solar, wind and energy storage will see continued strong support under this legislation. Their incentives would remain in place until the next decade. We would see a lot of benefit for fuel-cell companies and companies involved in the development and transportation of green hydrogen - that would be a major area of support. Existing nuclear power plant owners would receive quite a bit of support as well. So, we do see quite a bit of benefit within this legislation, really providing strong economic support really across the board, but a few areas such as hydrogen that do stick out. But I'd say broadly, if this legislation is passed, clean energy investors would view this as a significant benefit for the entire sector because it is so comprehensive.Stephen Byrd Before we close, Jess, I wanted to ask you about how this might move the needle globally. Europe is clearly out in front on climate legislation, but assuming some or all of these proposals make it into a final bill, how likely is it that we could see similar government action globally?Jessica Alsford It's a timely question, Stephen, really, because we now have COP 26 conference coming up in November. It's being held in Glasgow this year, and we're expecting over 100 world leaders to attend. So, this really should be a catalyst for seeing far more climate focused action globally. Aside from the EU and the US, all eyes are certainly going to be on China. And here, our chief China economist has been writing about a shift in regulatory priorities, so China now are thinking more about a balance between growth and sustainability. And specifically on climate, there are three pillars where we expect to see action from China. First of all, investments in technology. Secondly, carbon pricing and finally on the green financing side.Jessica Alsford Stephen, on Climate Week, thanks for taking the time to talk.Stephen Byrd Any time, Jess. Great speaking with you.Jessica Alsford As a reminder, if you enjoy Thoughts on the Market, please do take a moment to rate and review us on the Apple Podcasts app. It does help more people to find the show.

21 Sep 20218min