Climate and inflation two new priorities for markets

Steen Jakobsen
Chief Investment Officer

Summary:  The taste of this increasingly toxic cocktail is permanently low growth, close to zero productivity and a monetary policy with no exit path.

Climate is an issue that can raise the temperature of conversation nearly anywhere. Are you a partisan in what is the oddly politically charged climate change debate or are you simply concerned about the climate based on the consensus of the scientific community? 

We don’t really care to join the debate or try to argue the scientific evidence of the extremely complex climate system. But the long-term reality is that nature is telling us that the cost of the present ‘model’ of economic growth is turning negative. Not only at the margin, but probably full blown negative in terms of the costs to society and the environment, upon which all economic activity, digital or otherwise, is based. We have simply passed the equilibrium point of economic growth versus its costs: natural resource constraints and diversity in nature to start with, and for the non-deniers the additional risks from CO2 emissions.

It has become increasingly clear that our accounting systems and measures of economic growth do a lousy job of measuring the total costs of our activity when there is no accounting for longer-term resource depletion and environmental harm. On top of that we have the damage wrought by the lack of price discovery over the last decade, as central banks have done everything to keep our unsustainable economic activity levels at maximum throttle to avoid a reset. This has not only eroded the long-term potential of our economies, but also led to a terrible lack of productivity as we chase existing assets with growing mountains of cheap financing rather than investing in new ways of doing things. 

How do we know the ‘turning point’ has been reached to change priorities? 
During Q4 2019 I travelled extensively from Cape Town in South Africa to Moscow, then on to Europe through the Middle East and out to Asia and Australia. Everywhere I touched down, the front page on the local English newspaper read: “Climate plan needed” – accompanied by a picture of the last local natural disaster. 

The fallout from the climate is now so costly for governments across the globe that additional spending (fiscal spending) is taken out to cover cyclones in Japan, drought in South Africa and Namibia, flooding in Indonesia and a shortage of onions in India. Over the last few days, the Australian government has pledged open-ended support to the hard-hit New South Wales region, after it was engulfed in flames with dire consequences for its flora, fauna and human life and limb, not to mention property. 

For the first time since WWII we sense a shift in which climate and the environment – not growth – will become the priority of governments and certainly their citizens, as shortages of food, clean water and air become existential questions. 

There will be major political fallout from this. First through the rising cost of living as food prices spike, then through a further rise in inequality. Make no mistake, more revolutions have been started over food prices than anything else: the French and 1905 Russian Revolution and the Arab Spring. The 2020s will bring more. 

For investors this comes at a bad time – exactly when they have both central banks and governments ‘onside’. 2019 saw all assets rise – yes, all assets – as major central banks went from quantitative tightening back to quantitative easing, and many governments started expanding fiscal deficits, including China, the UK, US and Japan. Early in 2020 you can already hear the market chanting: “Fiscal expansion, fiscal expansion, MMT, MMT!” 

What the market does not see or want to see is an inflation scare. Inflation is expected to continue to fall, driven by demographic shifts, falling populations and lack of productivity, but this ignores the bigger risk of supply disruption. I do realise that most of today’s readers and traders would not have been born or around in the 1970s, but back then stagflation killed growth and the markets. This was driven by two major factors: an over-easy Federal Reserve and supply constraints. Does this remind you of something? 

Similarly to now, the pundits at the time had written off inflation as it had not materialised through the late 1950s and most of the 1960s, but the OPEC embargo changed that. The rise in oil became the catalyst, but the real culprit was an extremely ‘generous’ Fed. Point? 

The consensus economic forecasts for 2020 rely on a cocktail of promises, including low inflation and low rates forever, an abolishment of price discovery, a full acceptance of monopolies in technology and non-commitment to reduce inequality. The output or taste of this increasingly toxic cocktail is permanently low growth, close to zero productivity and a monetary policy with no exit path, as seen recently as the US Fed became not only lender of last resort for the repo market but also tilted toward full monetisation of the US federal deficit. 

There are three ways the status quo can change in 2020: 

Political – a change of US President would create a new impulse both politically and economically. 

Credit failures – the blown out value of the market becomes an issue, the loss of control over repo by the Fed generates massive event risk in credit space with the US shale sector being most exposed. 

Inflation/climate – The combination of climate sending a signal of distress – raising the cost of food, water and clean air – with an enormous underinvestment in infrastructure means the market becomes so complacent that it’s the perfect storm for a wake-up moment that spikes volatility when the next disaster strikes. 

The huge internet monopolies and asset markets have been so pumped up by mispriced money and central bank forcing that we are clearly in the frothy phase of the cycle, with echoes of Gordon Gekko’s “Greed is good!” bouncing around the market’s echo chamber. Greed might be fun – but it’s not very productive. The lack of focus, lack of accountability and lack of respect for nature is about to change the dynamics of how politicians get elected, how economic growth is measured and, most importantly, how society prioritises its resources and activities. 

Climate will most likely be the long play for the 2020s and with this piece we hope to engage and start a new branch of Saxo Research, where we apply a climate and environment filter on all investments and assets impacted by this change. This Quarterly Outlook has plenty of discussion topics and investable ideas. As Julius Ceasar said as he crossed the Rubicon: Alea iacta est – “the die is cast” as we have reached the point of no return. 

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