What Was the Deal With 2018—and What Can We Expect in 2019?
End-of-year 2018 was one of the worst that U.S. stock markets have experienced, and traders had no trouble finding reasons for pessimism. Like, maybe the end of democracy or at a minimum a slowing of its economic benefits, is nigh. Beginning in December, the U.S. government was closed “indefinitely,” the shutdown was kicked down the road to the next Congress and the new Congress is, as of this writing, in a stalemate with the executive branch. An economy-shrinkingtrade war is in effect. The IPCC told us we have 12 years to get our act together on climate disruption, and a U.S. federal climate change report described the dangerous consequences for American farmers if changes aren’t made soon.
It’s enough to make you ask, “What’s the point of being worried?”
Stewart Brand wrote, “Science is the only news…Human nature doesn’t change much; science does, and the change accrues, altering the world irreversibly.” In that light, this period is likely to be remembered by history less for Trump and more as the time when humanity took control of its own evolution, artificial intelligence (AI) began to usher in a new world order and we either lost or regained control of our system-level risks. It is in these last three pieces of our “only news” (as Brand would have it) that we see our present paradox: risks and innovation are peaking together, today. It’s not clear to which side of the knife’s edge humanity will fall: toward an unimaginably better future of abundance or to an unimaginably worse one of ruin and dystopia.
This double precipice is why we have to invest to manage the risks that matter.
In 2018, and particularly in Q4, markets began exhibiting the volatility we predicted would occur within the context of unpredictable political leadership. At the same time business results, if not share prices, have been improving steadily in many Next Economy areas. One of our holdings, First Solar,was a prime example of this. So what did we observe about the ongoing transition to the Next Economy in 2018? (For those who may want a refresher on our thesis of Next Economics, a quick audio overview can be found here and a more thorough white paper treatment is here.)
Growing Corporate Commitments to 100 Percent Renewables-Based Operations
In 2018 we saw de-politicization of renewable energy as an idea. Corporations and governments around the world made formal commitments to deriving 100 percent of their electricity production from renewable sources, usually meaning wind and solar supported by battery storage. A Yale survey reported that 81 percent of Americans, including 64 percent of Republicans, now support renewable energy. We’ve always believed that renewables represent great economic development and wealth creation opportunities while countering climate disruption and reducing pollution. Therefore wind and solar should not be pawns in culture wars, and, more generally, innovation shouldn’t and ultimately can’t be contained by ideology.
At the end of 2018 RE 100 (an informal group of global companies committed to running their operations on 100 percent renewable energies) had 158 of the world’s largest companies as signatories. Many companies are eager to adopt renewable energies for the same reasons we invest in them; they de-risk the global economy relative to fossil fuels and they are cheap, meaning they increase the productivity of every dollar invested in a company. It’s not surprising that 2018 was a record year for corporate purchasing of renewable energies. As Deloitte said of energy in 2018, “Solar and wind move from mainstream to preferred.”
Electric Vehicles are Booming
According to the U.S. Department of Energy, “1 million plug-in vehicles have been sold in the United States” as of October 2018, up from zero in 2010. Electric vehicles reached a per-month sales crescendo (until the next one) of 45,000 vehicles per month. This is occurring even though overall vehicle sales are down, meaning EVs are increasing their market share. This has significant implications not only for climate change and pollution mitigation but also for industries all along the value chain of EVs—advanced materials, battery storage, microgrids, AI (including autonomy), charging infrastructure and electricity demand versus liquid BTU demand. All these areas are likely to see more rapid growth. Audi, Mercedes-Benz, BMW and BMW Mini, Nissan, Porsche, Kia and Volvo all have announced new all-electric vehicles for 2019 and many more will follow in 2020, including VW. We predict EVs will continue to be responsible for any new growth in the personal vehicle space.
California is Leading
The world’s fifth largest economy showed us how to accelerate the transition to sustainability. The highlight was SB 100, a law that set a target of 100 percent clean energy by 2045, making California the largest political jurisdiction to make such a commitment. The law confirmed new standards that require panels to be installed on any new home or low-rise residential building of three stories or less—about 80,000 new homes a year. That could quadruple the amount of solar in California.
The state’s 100 percent zero-emission bus rule states that all state transit authorities must convert to 100 percent electric transit vehicles by 2040. By 2029, all government transit bus services have to be zero-emissions vehicles and California is providing incentives for cities to get there.
In electricity, transit and electrification of homes (including heating), the importance of California’s efforts shouldn’t be understated. Over and over, we’ve seen that centers of innovation lead to global changes, even in the face of significant resistance. The economic scale of the state alone means businesses around the world hoping to sell into or work in the state must adapt to their policies.
However, the political economy of technology is now visibly ascendant. The days of policy preceding change are ending, and policy is increasingly reacting to tech- and innovation-based change. Thus, for us, investing on the basis of proactive policy will be of limited utility. California’s leadership is outstanding, but it works because the underlying green tech is productive and economically efficient. All that said, intelligent policy will pay for research that is likely to improve green tech over the long-term but does not have immediate return on investment. Here, too, California is “going solo” and in the lead.
AI is Rising
My firm, Green Alpha, invests along the value chain that is enabling AI to emerge as a source of innovation (e.g., Google’s quantum computing) and, perhaps more important, a way to address problems insoluble by human minds. Ultimately is may even enable humanity to have good standards of living around the world without further crossing planetary boundaries. Taking the long view, Steven Strogatz has put it down clearly: “We will recall with pride the golden era of human insight, this glorious interlude, a few thousand years long, between our uncomprehending past and our incomprehensible future.”
Green Alpha’s 2019 Outlook
Speaking of the future: In the near term, a lot will have to happen for markets to become less volatile. Markets thrive on political and economic stability, free trade, cheap capital and stimulative fiscal policies, all of which are in question or even at bay in 2019. Fred Smith, CEO of FedEx, explained the situation in his firm’s most recent guidancecommentary, saying, “Issues we’re dealing with today are induced by bad political decisions.” Among these, he listed unilateral tariffs by the U.S., Brexit and state-owned enterprise initiatives in China as “things that have created a macroeconomic slowdown.”
As stock prices have been declining, bond prices have been going up, which is what happens when equity markets begin to lose confidence and traders prefer the perceived security of debt instead. That means lower yields, but it also means cheaper borrowing for mortgages and for corporations looking to invest more in their businesses, so the rotation to bonds is not an unmitigated negative for the economy.
In the U.S., one of the key economic developments of 2018 was tax reform. Policymakers inarguably gave the American economy a short-term boost by lowering taxes. This break was primarily given to corporations, secondarily for wealthy individuals and families, and lastly (and not much) for average people. That boost takes many forms, including capital spending, increased consumption, more market liquidity, more corporate stock buybacks, mergers and acquisitions, and some dividend increases. In the early part of 2018, markets responded accordingly, rising in Q1 and Q2, even in the face of political uncertainties and trade wars.
What about the long-term effects of tax reform? We see two probable, unfavorable areas of outcome. One, and the more serious, is the effect it will have in increasing the scope and intensity of structural wealth inequality—a dangerous systemic risk. Too much dynastic, unearned, concentrated wealth in the hands of too few does not tend to end well, historically speaking. The second negative outcome will be the effects of a growing national debt: potentially more interest expense, less capacity for expenditure where needed and downgraded faith in our currency and debt instruments are the usual long-term effects of too much sovereign debt. As long as the U.S. dollar remains the world reserve currency, the debt and deficit risks can be managed fairly easily by money creation and productivity gains. But if global confidence in America diminishes, and as other currencies including sovereigns and cryptos become favored stores of value, the U.S. could face a real debt crisis. Think of Greece, but with an economy 954 times larger (in 2016 GDP terms). This latter risk isn’t likely to manifest in 2019, but the possibility is now visible. Not too long ago, it would have been unthinkable.
A meaningful socioeconomic indicator to keep an eye on in 2019 will be improving inclusivity in business. As our own portfolio results indicate, more diverse teams are associated with better business outcomes. They are more innovative, solve problems better and have better risk profiles. To look for progress, we can look at metrics like increasing women and minorities in leadership teams and on boards of directors. Diversity economics also encompasses less formal observations such as proportions of women invited to speak at conferences, women and minorities authoring papers and other influential content, and entry-level hiring statistics. As mentioned above, widening inequality is one of the primary risks the economy is facing, and de-fusing this risk is a clear way to both seek returns and lower the overall risk profile of the global economy while preserving wealth and purchasing power overall.
What is Likely in 2019 for the Transition to the Next Economy?
We expect that prices for wind and solar will continue to fall dramatically and record low contracts for power purchasing will continue to be announced. This will put coal and natural gas in a less competitive position, and 2019 won’t be close to the last year of this general trend. Corporations from transportation to utilities will continue to announce, work towards and reach 100 percent renewable energy and/or zero emissions goals. These two effects are locked in a virtuous cycle: The more deployment of zero emissions tech, the less expensive it becomes, leading to more demand and still faster growth. Even in the event of slowing global economic growth overall, zero emissions tech will continue to gain market share from dirtier, more expensive, riskier technologies like fossil fuels and internal combustion.
Economic, cultural and technological change will continue to accelerate, as will the world’s system-level risks. We developed our Next Economy investment framework because of this confluence; we invest in the Next Economy and de-risk our portfolios from risks like resource degradation and climate disruption. In the end, this will be the only way for investors to preserve their purchasing power in the face of change. First principles require us to evaluate the world as it is and act accordingly.