Short-term moves
Market conditions have been unforgiving so far in 2016. While the S&P 500 Index is up a benign-looking 2.3% year-to-date [1], this masks a significant reversal in many of 2015’s momentum trades. Having been the worst performers last year, the energy and material sectors are among the best performing sectors this year, thanks to the bounce in oil and other commodity prices. Conversely, healthcare, financials, and technology are among the weakest sectors this year. The political environment in the US has cast a shadow over the healthcare sector, with both increasing scrutiny on drug pricing and the Internal Revenue Service (IRS)’s moves to curb tax avoidance: this derailed the largest pharmaceutical merger in history between Pfizer and Allergan.
Capital market disruption
Sifting through the noise, we think this sector rotation will prove short-lived. The main reason for the persistent low interest rate environment is that productivity growth remains very weak, evidenced by the fact that debt continues to rise as a percentage of gross domestic product (GDP). Part of the reason for this is that there are some very powerful social and environmental trends that are changing the shape of the global economy. The two most significant are an ageing demographic and the transition to a low carbon energy system. Both of these are causing significant disruption to the way in which global capital markets function. Our sustainable investment strategy takes a thematic approach to stock selection, investing in companies that are thinking strategically about these long-term trends.
Healthcare and energy: trends in focus
According to a report delivered to the US Congress by MedPAC [2] last year, an average of 10,000 people retire in the US every day, and in the next 15 years those enrolling for Medicare are projected to rise c50%, from 54 million to more than 80 million. Greater scrutiny over healthcare costs is inevitable given this dynamic, but this trend should still be a positive tailwind for healthcare providers that offer genuine value. We are also contrarian on the energy sector. Although the sector has rebounded strongly, we think this is an area where investors should continue to exercise caution. Over the next 15-20 years the global economy will have to break from its dependency on fossil fuels and transition towards a low carbon future in order to limit climate change. We note that five US coal companies have entered Chapter 11 bankruptcy proceedings since May 2015 – Peabody Energy being the latest casualty.
Planning for a post-oil era
Along similar lines, we view other recent developments as sounding the death knell for oil: only shortly after Tesla received more than 325,000 reservations in the first week of launch for its mass-market electric vehicle, Saudi Arabia announced arguably its greatest set of economic reforms. Saudi’s ‘Vision 2030’ aims to transition the country away from oil dependency, including plans to float part of Saudi Aramco, the world’s largest oil company, in potentially the biggest initial public offering ever brought to market.
With approximately 70 years of remaining oil reserves at current production levels, and as one of the world’s largest consumers of crude oil themselves, it seems logical to us that Saudi is starting to divest and to diversify into alternative energy sources such as solar. The assumed planning price of oil in Saudi’s economic roadmap is US$30 per barrel, which does not seem conservative. To us, ‘Vision 2030’ brings yet more evidence that a ‘post-oil’ era will come about, in which already discovered unburnable carbon assets will have to be kept in the ground.
