CEO COMMENTARY

IS ANYONE LISTENING?

With COP26, the United Nations Climate Change Conference underway, I, like so many others, am asking the question, “Is anyone listening?”.

For many parts of the world today, the effects of climate change are not 10 years away. They’re happening now and sadly, our most vulnerable communities will be more severely impacted.

Here are the facts;

• Population is expected to increase from 7 to 9 billion people over the next 50 years
• We are currently using the equivalent of one and one-half of our planets worth of resources each year to produce the goods and services today’s lifestyles demand
• Based on current trends, the world will need to produce 56% more calories in 2050 than it did in 2010
• If farmers and ranchers met that demand by clearing forests and other ecosystems for farmland, it would equate to approximately ⅓ of the size of the US
• As a result, it will be impossible to stay below 2 degrees Celsius of global warming even if the world’s fossil-fuel emissions are rapidly reduced

CLIMATE CHANGE LEGISLATION ISN’T JUST ABOUT REDUCING FOSSIL FUELS.

Food and agriculture is the mother of all sustainability challenges. If current unsustainable production and consumption patterns continue, our planetary resources will become increasingly strained, resulting in greater social and environmental instability. Making circumstances worse, extreme weather and repercussions from climate change will further stress food chains and threaten livelihoods. The strains associated with climate change will likely spread across the world not only impacting low income communities, but smaller and rural communities who will be disproportionately impacted.

Moreover, when land is cleared of trees to allow for farming, the large stores of carbon that have been locked away in trees are released into the atmosphere. The destruction of the South American rainforests and the North American primordial forest is having a devastating effect. Tropical deforestation alone accounts for up to 15% of net global carbon emissions each year.

The world’s agriculture system will also need to be overhauled in order to feed billions of people without triggering a climate catastrophe. Farming, more than any other industry, might be our best hope for curbing climate change.

So what’s the roadmap for change?

• Divest from fossil fuels and any company that is a part of the “Carbon Underground 200”
• Invest in renewables
• Use your shareholder voice to advocate for change
• Boost productivity to produce more food per acre of land
• Reduce livestock emissions. Cow burps are responsible for 39% of greenhouse gas production related to the global livestock industry
• Reduce emissions from fertilizer use, Approximately half of U.S. agricultural product emissions, and 20% globally, are related to the use of synthetic fertilizers and manure.
• Encourage and support the development and expansion of on-farm renewable energy
• Stabilize and sequester carbon in vegetation and soils and integrate more trees into farmland
• Reduce food loss and waste
• Become a vegetarian, reduce your beef and lamb consumption, and eat more chicken. Poultry production has about one-eighth the climate impact of beef production

At Newday Impact, we are keenly focused on collaboratively working with like minded institutions and individuals that move the needle in deep and transformative ways. On November 1st, we introduced a new “Climate Action” investment portfolio. The portfolio is “climate positive-carbon negative”. In aggregate, the portfolio delivers what is a net negative carbon emission score by investing in companies that are leaders in reducing their GHG emissions.

In association with this portfolio, we have partnered with two leading climate organizations, Etho Capital, an index provider and data analytics company that’s doing deep evaluation of scope 1-3 emissions data at corporate organizations, and Climate Changemakers, a non-profit, 501c4 organizations doing admirable work to support climate change legislation and action. Newday is contributing 5% of its net revenues on its Climate Action portfolio to Climate Changemakers.

On 11/2, Newday Impact, Climate Changemakers, Project Drawdown, Etho Capital, HIP Investor, and Pottinger hosted “60 Minutes to Save the World”. While the title is tongue and cheek, its message and content was intended to encourage everyone to join the movement in taking on climate change. If you missed this important event, you can view the recording at www.esgx.org.

Please join us in the fight against climate change and visit us at www.newdayimpact.com/climateaction to learn more.

NEWDAY IMPACT MONTHLY COMMENTARY

Gordon Telfer, CIO, Co-Portfolio Manager, Newday Impact

Overview

This month’s note tackles falling COVID-19 cases, a wide range of economic developments, and the big three issues on my mind right now: the Chinese economic slowdown (a rising concern), supply chain issues (an ongoing but slightly diminishing concern) and inflation (a serious and now steady level of concern).

COVID-19 infections mostly falling

COVID-19 remains mostly in retreat. This is true across most of the U.S., and much of the developed and emerging world.

Global COVID-19 cases and deaths

10/17/2021. 7-day moving average of daily new cases and new deaths. Source: WHO, Macrobond, RBC GAM

That being said, a few prominent exceptions do exist. It is notable that places like Australia and Singapore, which both recently abandoned zero-COVID policies, both have experienced a surge of new infections. Further, there is tentative evidence that infections are beginning to rise again in parts of Europe. This includes Germany, France, and the Netherlands. We continue to monitor developments closely, as we head into winter in the northern hemisphere.

A wide range of economic developments

I follow multiple economic indicators. The following are some of my favorites:

Real-time measures of traffic congestion find that European traffic levels at both morning and afternoon rush hours are now back to their pre-pandemic norms. This is ahead of most North American and Asian cities, which remain shy of prior norms. We view this as a proxy for a return of workers to offices, but I think it also says something more broadly about the normalization of daily life. Admittedly, to the extent that public transit has become less popular, it exaggerates the extent of normalization.

Mixed traditional U.S. data: U.S. payrolls for September landed at +194,000 jobs, less than half the consensus number. But this disappointment was tempered by the fact that upward revisions uncovered 169,000 additional jobs over the prior months, and more workers were absorbed than would be strictly required to keep abreast of population growth. Although 5 million more Americans remain unemployed than before the pandemic, the unemployment rate has nevertheless fallen to just 4.8%.

U.S. jobless claims hover around pandemic low

Week ending Oct. 2, 2021. Shaded area represents recession. Source: Department of Labor, Haver Analytics.

It should be said, that while the rate of hiring has seemingly slowed, the level of initial jobless claims has continued to improve. It registered just 293,000 new initial claims in the latest week. This number is near to the 222,000 registered in the last week of 2019 – a half-century low – and is many miles away from the more than 6 million new jobless claims registered in the worst week of 2020!

Finally, the twin Institutes for Supply Management (ISM) indices for September, suggest that the U.S. economic deceleration may be ending. The Manufacturing component rose to a robust reading of 61.1, the highest in four months. And the Service measure clocked a solid 61.9. This was the second highest reading in four months and spectacular by any normal standard. As such, the Federal Reserve can probably still begin its tapering operations before the end of the year. This move has been sufficiently well telegraphed, that I believe it should already be priced into the stock and bond markets.

The Chinese economic slowdown

The Chinese economy slowed sharply in the third quarter, reporting a “mere” 4.9% year-over-year increase. But the real story is hidden within this figure. The new quarter – the quarter from July through September – yielded a mere 0.2% increase. This is a tiny addition for a country like China that is used to a growth rate around 7 times faster each quarter. Growth should be somewhat better in the fourth quarter, but still significantly lower than normal. Further, we model for a sub-5% growth rate in 2022. This is well below its pre-pandemic norm and below the consensus forecast, albeit still quite good by the standards of nearly any country, other than China.

I do want to be clear, none of this is because China’s pandemic economic recovery is stalling out. The economy long ago recovered from most aspects of the pandemic. Instead, it reflects several more recent headwinds:

• Insufficient electricity for factories (We think short-lived)
• Global supply chain problems (We think remain distorted for several more months/quarters)
• The Chinese government corporate crackdown, skewed toward the tech sector (We think near-term negative, but longer-term could be positive if it creates additional competition into the economy)
• Housing market excesses, as government rules tighten and industries tied to real estate feel the pressures (We think the property sector will continue to be a drag on the economy)

Supply chain issues

Supply chain problems are likely to persist, to some degree, possibly for years given the world’s transition to just-in-time (JIT) inventory systems. The auto industry has been particularly affected due to a shortage of chips. As a result, there just are not enough vehicles to meet demand. For example, U.S. passenger car sales, in September, fell by 25%. However, it must be conceded there have recently been several important improvements to the supply chain dynamic, and that the intensity of the problems should fade with time. For example: The number of container ships waiting at anchor, or in holding areas, for their turn to unload at either of Southern California’s two main ports has begun to edge lower, for the first time since last spring (see next chart). Part of this may be attributable to the fact that the Port of Los Angeles will now operate 24 hours per day (in keeping with most other major ports). This is a very important development, as the two ports unload an incredible 25% of American imports.

Container ships at anchor or in holding areas

As of 10/14/21. Marine Exchange of Southern California

In short, the situation looks better than before, but it is a long way from being completely resolved. We expect significant disruptions for several more months, moderate disruptions for several quarters, and then lingering distortions that may persist for a few years. This is both growth-negative and inflation-positive.

Inflation tidbits

There are many short-term inflation drivers at work right now. These include supply chain issues and a spike in commodity prices. The term “transitory” in the context of “high inflation is transitory” has become way over-used in my opinion. The reality is that what was initially thought to be an inflation spike lasting a few months, last spring, shows little sign of abating. 

Energy costs have long ago revived from their initial pandemic collapses. Prices have lately pushed significantly beyond the pre-pandemic norm. For example, West Texas Intermediate (WTI or NYMEX) crude oil prices per barrel, as of October 29, 2021, is now $83.57 per barrel, the highest in seven years. Natural gas prices have increased to an even greater extent, with UK and EU contracts trading at up to 10 times their start-of-year levels. Coal prices have now also soared, in significant part, as coal is used as a substitute for natural gas, but also due to a dispute between China and Australia. The global benchmark thermal coal price is now trading at triple the price of late 2019. All these developments are broadly bad for economic growth (with exceptions for energy-producing nations) and contribute to higher global inflation.

Scotsman’s View

As an investor, all of this suggests to me there may be less room for company profit margins to rise further in the future – a challenge for all of us who have benefited from the prior increases. Wage growth may rise somewhat more quickly than expected given shortages in workers, and employees may succeed in negotiating other benefits, such as working from home. Inflation could be higher, (though we think demographic changes and increased productivity via technology and other forces remain net deflationary and might outmuscle this effect).

For me, this episode also illustrates that our new era of decarbonization brings with it a few important implications, as demand pivots away from fossil fuels. Companies and investors are now reluctant to invest further into fossil fuels because peak demand arrives within a few decades. In turn, I believe we should expect greater energy price volatility because suppliers will respond less enthusiastically to positive demand shocks or negative supply shocks. That is arguably part of what is transpiring now.

Isn’t it ironic?

Isn’t it ironic that asset management firms claiming to be true Environmental, Social, and Governance (ESG) investors don’t look anything like the constituents in which they invest in?   

While we continue to see a groundswell in activity and conversation around diversity, equity and inclusion (DEI) in this country, the U.S. financial industry lags in its hiring of diverse employment. If DEI has become such a dominant sustainability investment theme, how can an ESG fund tout the importance of investing in socially responsible companies when it doesn’t practice what it preaches?  

Empirical evidence shows that including diversity in the workplace creates value and can have positive effects on team dynamics and performance. A study of Gender Diversity and Corporate Performance done by Credit Suisse in 2012, found that companies with more women on the board or at top management levels “exhibit higher returns on equity, higher valuations, and also higher pay-out ratios”.  A more recent study done by McKinsey & Co. in 2019, showed companies ranked in the top quartile for executive gender diversity were 25% more likely to show above-average profitability than the companies whose executive teams were in the bottom quartile. For cultural and ethnic diversity, that number was 36% more likely to show above-average profitability. In addition, although the financial industry has shown an upward trend of minority representation in senior executive positions from 2008 through 2015, increasing from 8% to 12%, according to a report done by the Knight Foundation using EEOC employment data, it still fails to have the reach of other industries. 

 Many say the lack of hiring diverse and qualified candidates in the financial industry is simply a supply and demand issue. However, academic research shows that often times unconscious biases, a form of prejudice and social stereotypes about certain groups of people that individuals form outside their own conscious awareness, creates the true shortage. While this is a complex issue, understanding, self-awareness, education, open dialogue and looking outside of typical networks are basic ways to combat diversity hiring problems.

While the industry as a whole is clearly not where it needs to be, NEWDAY has reached an inflection point and is proud to be a champion of change when looking at our firm from a diversity and inclusion lens. Here at NEWDAY, we are leading the charge of designing diversity as a business strategy and not just a human resources function. Our executive leadership team is comprised of 50% female, 25% minority, and 25% LGBTQ. We are equally proud of our diverse and experienced team’s importance placed on philanthropy, community engagement and volunteerism.

We are reminded of the quote coined by author William Gibson, “The future is already here, it’s just not evenly distributed.” DEI initiatives already exist within NEWDAY’s business, hiring and investment framework, so our hope is that the inequities of today in the asset magnement industry will no longer be the norm of those living in the future. 

To gain further information on NEWDAY’s DEI portfolio, please visit Diversity and Inclusion | Newday (newdayimpact.com).

Country Governance Research Commentary
October 2021

ESG Trends – COP26

The United Kingdom will host the 26th UN Climate Change Conference of the Parties (COP26) in Glasgow over the first two weeks of November.  The meeting of the signatories to the UN Framework Convention on Climate Change (UNFCCC) has taken place every year since 1995, having only not occurred in 2020 due to the pandemic.  More than 100 world leaders will be coming together to try to set new emissions reduction goals following up on the 2015 Paris Agreement.  The Paris Agreement called for limiting global warming to 1.5°C above pre-industrial levels by 2100.  However, the IEA’s World Energy Outlook 2021 finds that today’s emission reduction pledges cover less than 20% of what will be needed to keep a 1.5 °C path within reach.  A global energy crisis, though, may limit any willingness from countries to make new ambitious commitments.  Developing countries will also be looking to the wealthy nations to provide financial support to better withstand the impacts of global warming and to help facilitate the transition to clean energy sources.  With the effects already being felt in extreme weather events across the globe the hope is that steps can be taken to avert a foreseeable catastrophe, but the path ahead won’t be easy.

Czech Republic

In legislative elections held earlier this month populist billionaire Prime Minister Andrej Babiš, and his ANO party, narrowly lost to a coalition of opposition groups. The Together (SPOLU) coalition was created earlier this year by three parties that agreed to put aside their ideological differences with the goal of ousting the prime minister from office.  Babiš became prime minister in 2017, coinciding with a rise in populism across the region.  As the founder of the Agrofert conglomerate, he has faced multiple investigations over allegations of conflicts of interest related to his business empire.  Shortly before the election, the Pandora Papers investigation of the secretive dealings of the world’s ultra-wealthy, revealed his purchases, through offshore shell companies, of properties on the French Riviera worth more than $20 million.  Sensing his declining fortunes Babiš campaigned heavily on an anti-immigrant and Eurosceptic platform.  He also invited the controversial Hungarian Prime Minister Viktor Orban to campaign with him. 

Implications:

In the end, his party won the most votes but lost its majority to an opposition coalition that promised policies closer to the European Union’s mainstream.  Babiš’s defeat is a setback for Europe’s populist politicians, and the opposition’s success is being seen as a possible model for politicians in other countries. Hungary has elections next year, and opposition parties there have selected a joint candidate in hopes of breaking Orban’s grip on power.

Poland

Since 2015, when Poland’s conservative Law and Justice (PiS) party came to power, there have been numerous disputes with the European Union over the rule of law and the independence of the judiciary.  The ruling earlier this month by Poland’s Constitutional Tribunal that the country’s laws had supremacy over those of the European Union is the latest escalation in a long-running saga.  The current dispute centers around a disciplinary chamber of Poland’s Supreme Court that was set up in 2018.  In July, the European Court of Justice (ECJ) said it should be shut down because it was neither sufficiently independent nor impartial.  Polish Prime Minister Mateusz Morawiecki asked the Constitutional Tribunal to weigh in on the issue, and in its just released ruling it backed the government’s position saying elements of the union’s law were “not compatible” with the country’s constitution.

Implications:

The unprecedented verdict strikes at one of the EU’s core tenets, which is the primacy of EU law.  The negative reaction was swift from across the EU.  The ECJ ordered Poland to pay a daily fine of €1 million until the disciplinary chamber is abolished.  Some have said the clash could lead to ‘Polexit,’ with Poland crashing out of the union.  However, Poles overwhelmingly support EU membership, so an eventual compromise is more likely. 

United States

Last month the Public Company Accounting Oversight Board (PCAOB) adopted a final rule implementing the Holding Foreign Companies Accountable Act (HFCAA).  The Act was passed in December 2020 in order to provide teeth to the 2002 mandate in the Sarbanes-Oxley Act that foreign jurisdictions allow the PCAOB to audit the auditors of public companies.  Despite over a decade of negotiations, Hong Kong and China have yet to comply with the requirement.  The HFCAA states that trading in a company’s securities on US markets can be prohibited if for three consecutive years the PCAOB determines it cannot inspect a company’s audit work papers.  SEC Chairman Gary Gensler has said the three-year clock began ticking this year and that they would begin identifying non-compliant companies in 2022.  As a result, as many as 270 Chinese companies could be delisted from US exchanges by early 2024.  In June, the Senate passed another bill that, if passed by the House and signed into law, would shorten the three-year timetable for delistings to two years.

Implications:

The passage of HFCAA and its possible accelerated implementation may provide the impetus for negotiations to begin once again with China over allowing greater transparency from their listed companies. There are also likely to be more companies moving listings to Hong Kong and other Asian markets contributing to the overall US-China decoupling trend.