In their latest market update, Ulrik Fugmann and Edward Lees, co-heads of our Environmental Strategies Group, give their take on the sell-off in equity markets. They reaffirm their positive outlook for environmental stocks whose current valuations do not, in their view, reflect the strong fundamentals of the underlying businesses.
Another volatile week in stock markets left the US S&P 500 index close to its lowest closing level for the year on Friday 20 May, down almost 19% from its high in early January.
The index is now close to a 20% decline, which corresponds to the popular definition of a bear market. In their account of this month to date, Ulrik and Edward analyse the recent market action and give their outlook for environmental stocks.
Here are the takeaways from their update in bullet point format. Click here to read the full May 2022 edition of ‘Thoughts from our Environmental Strategies Group’ 
- We are again seeing the inefficient market hypothesis at work amid animal spirits and the tenants of behavioural finance theory. Over long periods, these play out in alignment with the traditional business cycle. This is driven by the forces of supply and demand (changes in gross domestic product), the availability of capital and expectations of what the future holds.
- Stock markets appear to be approaching a phase of capitulation – that time when investors ‘throw in the towel’, giving up any previous gains by selling their positions during a decline.
- We should consider that the business cycle consists of four distinct parts. As active portfolio managers, our first orientation point is the stage at which the economy is within the cycle:
- Expansion (early cycle)
- Peak (mid-cycle)
- Contraction (late cycle)
- And if things get worse, a trough (recession).
- Today, developed economies are in the late phase of the cycle. From here, they can either glide toward baseline growth or descend into recession. High volatility will continue as the market, driven by data on the economy’s speed, pivots between these two outcomes.
- The fundamentals of the US economy are robust, but the US Federal Reserve will have to slow growth to stem inflation. The market is spooked by concerns that the Fed may tighten policy either too far, or too fast, or both.
- The businesses underlying environmental stocks have long-duration growth characteristics. As such, like growth stocks, they are vulnerable to the prospect of higher real rates, which typically mean future cash-flows are more heavily discounted by investors, lowering the stocks’ current valuation.
- Our view is that barring additional exogenous shocks, a US recession is unlikely. Ultimately, we expect the secular, deflationary forces of demographics, tech-led efficiency gains, the declining velocity of money and global over-indebtedness to reassert themselves.
- If, as we expect, inflation pressures subside in the coming months and quarters, markets should shift from a narrative of ‘high inflation and rising policy rates’ to ‘high, but falling inflation’. That would pave the way for a more positive environment for growth stocks.
- Environmental solutions companies have delivered strong returns since 2019 relative to the market. They are now trading at levels not seen since 2019, although there have been major advances in the factors supporting them. Multiples can always compress further given sentiment and flows, but our deep fundamental analysis, even incorporating conservative and high discount rates, points to significant upside if companies deliver into their growing markets.
- In our view, the fundamental signals for environmental solutions companies globally are flashing green, supported by a generally strong reporting season, while noise from market sentiment, a lack of liquidity and fear is flashing red. If history is any guide, the signals prevail, the noise subsides and fundamentals ultimately matter.
- In this sense, “it is not different this time around”.
If you wish to receive regular commentary and/or monthly reporting from the Environmental Strategies Group, send an email to LIST.AMENVIRONMENTALSTRATEGIESGROUP@bnpparibas.com>
 The full edition of ‘Thoughts on the month to date’ was distributed on 10 May 2022