IMPACT COMMENTARY

Investing In Your Family’s Future-Three Gifts That Keep on Giving

With the holidays fast approaching, many parents and grandparents are trying to decide on appropriate and meaningful gifts for their children and grandchildren. Several gifting strategies have the dual benefit of illustrating the advantages of long-term saving and investing, while providing parents and grandparents an opportunity to share life lessons with loved ones during the holiday season. 

A HOLIDAY GIFT OF STOCKS

A gift of equities will give children a financial head start for a lifetime. Purchasing stock can help educate your heirs on the importance of financial responsibility, and will demonstrate the value of building a nest egg. Stock-picking also can open a window of insight into the national and global economies when you discuss how to make choices among companies and sectors. 

Seeding a portfolio of common stock can be accomplished for a relatively small amount of money – and minimal fees – while building a foundation of knowledge about the financial markets. For a young person, owning shares in The Walt Disney Company, Apple, or Amazon.com can be a learning experience coupled with fun as they receive annual reports and are invited to shareholder meetings. Sticking with high-quality growth companies also can pay off handsomely: $1000 invested in Apple on the IPO in 1980 would be worth approximately $1.2M today!

Building a portfolio of companies that are socially responsible can also bring about an experience that teaches younger people that their capital can be used as a mechanism to do good in the world. Newday’s investment strategies are focused on companies that are focused on creating value for all of their stakeholders and as a result have historically delivered stronger investment returns and deeper impact.

FINANCING HIGHER EDUCATION

Another valuable investment vehicle for educating children – both financially and literally – is a college savings plan. With college tuition rates inflating at 8% a year, and doubling every nine years, the funding of a 529 college savings plan is more important than ever. According to the 2019 “Trends in College Pricing” report, tuition and fees for a private school education are approximately $36,900, $26,800 for out of state public school, and $10,400 for public in-state per year. 

Since 1985, the U.S. inflation rate has increased 107%. But during this same period, college inflation has increased 467%. 

For the 2021-22 academic year, average tuition and fees rose by 1.3% to $3,800 for students at two-year schools, 1.6% for in-state students at four-year public colleges, reaching $10,740, and 2.1% for students at four-year private institutions, to $38,070. After adjusting for inflation, average tuition and fees declined. 

The following chart illustrates the divide through 2015: 

While contributions to 529 plans are not tax-deductible, your investment grows tax-deferred and distributions used to pay for college are federally tax-free. Some plans also offer state income tax benefits. Allowable contributions can be substantial: a single plan may be adequate to fully fund your student’s education. 

ANNUAL GIFTING FOR TAX BENEFITS

Distributing investment dollars to your beneficiaries today is another way to provide your family with important tax advantages. In 2021, every individual taxpayer can use the $15,000 gift exclusion, or $30,000 per married couple. A taxpayer may make as many gifts as he or she chooses, as long as no recipient gets more than $15,000 of value in any one year from any one person. 

If you make annual exclusion gifts to your children or grandchildren now, they receive the benefit of your generosity without paying federal tax on this income, and you receive the pleasure of watching your loved ones enjoy their gifts. If you were to make the same bequests upon your death, the funds would be part of your taxable estate. 

Funding a comprehensive investment plan for your family’s future not only circumvents excessive tax requirements, but is one of the most important gifts a parent or grandparent can make this graduation season. Ultimately your generosity may fund a university education or the purchase of a new home, help start a new business, finance a world trip, or support a young adult while he or she works to help those less advantaged. Whatever the outcome, you can be sure your gift will make a life-changing difference to your loved one. 

CAPITAL MARKETS COMMENTARY

Overview

This month’s Scotsman’s note tackles a wide range of topics, beginning with the Omicron variant of SARS-CoV-2, the latest strain of the coronavirus to be designated a “variant of concern” by the World Health Organization (WHO). We then tackle new issues including the re-appointment of Fed Chair Powell and a recap of the COP26 climate change summit. Then finally, we review recent economic and inflation trends, check in with supply chains and the oil market.

Just when you thought it was safe to go back… Omicron B.1.1.529 variant surfaces

Continuing a trend that has been in place for the better part of two months, COVID-19 infections have continued to rise in the developed world. In recent days, more and more countries are reporting cases of the new Omicron variant, which has an unusual combination of mutations that may enable it to spread faster. Scientists are also trying to determine whether the current vaccines are effective in combatting it.

COVID-19 emerging markets vs. developed markets infections

As of 11/21/2021. Calculated as the 7-day moving average of daily infections. Source: WHO, Macrobond, RBC GAM

So far, this virus variant has not been found in many people, so it is impossible to for us to predict if it is anything to be really concerned about because we cannot clearly see how it behaves in the real world. When the Delta variant emerged, we saw very rapid growth within weeks. So far, we have not seen any data anywhere in the world that is clearly demonstrating this behavior in B.1.1.529, yet. Generally, surveillance in sub-Saharan Africa has been poor, so the lack of real-world evidence is simply because we do not have enough eyes on the ground. If the variant has truly been found in multiple countries, then it could represent it is spreading rapidly beneath the surface, and perhaps even outcompeting Delta.

Fed Chair renewal

A key source of uncertainty this autumn (fall for our U.S. readers) was whether U.S. Federal Reserve Chair, Jerome Powell would be nominated for a second term, or instead replaced by the more left-leaning Lael Brainard. That uncertainty has been resolved. President Biden has opted to revert to the long-standing tradition (broken four years ago by President Trump) of nominating the Fed Chair for a second four-year term.

We think the decision on both appointments, yields a slightly more hawkish policy, though it is hardly hawkish in an absolute sense. Nonetheless, at the margin, the decision would appear to be U.S. dollar positive, yield positive and possibly stock market negative (though the stock market may care more about stability and ending high inflation than it fears incrementally tighter monetary policy). Given rising inflation levels and the extent to which the U.S. economy has recovered, it is arguably for the best that the Fed does not pursue a more dovish path. All this being said, Lael Brainard will still be involved in the monetary policy process. She is Vice Chair, and we expect her to supervise the banking sector in that role.

COP26 climate review

The latest edition of the annual global climate change summit – COP26 UN Climate Change Conference, hosted by the UK in partnership with Italy, started on October 31 and ended on November 12, 2021, in the Scottish Event Campus (SEC) Glasgow, UK (my hometown btw). Notably, 151 countries announced incrementally more aggressive climate plans to reduce emissions by 2030. More importantly, specific agreements were reached to:

• • Reduce methane emissions.
  • Stop and reverse forest loss.
  • Align the financial sector with net zero goals by 2050.
  • Phase out internal combustion engines.
  • Reduce the use of coal more quickly.
  • Provide more support for poor countries pursuing their own climate mandates.

Despite this progress, commitments fell short of levels needed to restrict climate change to a 1.5-degree cumulative increase. That target now seems unlikely to be met, given that global emissions would have to be cut by more than 50% by the end of the decade for it to be achieved.

We expect future meetings to yield additional promises. Laggards such as China, Saudi Arabia and Australia may participate more enthusiastically in the future. Unfortunately, we anticipate many countries will probably fail to reach their targets. In turn, we assume the actual temperature change ends up being close to 2.5 degrees. There are a variety of economic consequences that emerge from this amount of climate change (and from policies designed to limit further warming). These are fairly small at the aggregate level. However, there is a great deal of uncertainty around them and there are massive implications for certain sectors. More to come on this…

Economic trends: Buy U.S.

The U.S. economic trend remains favorable: the mini acceleration we discussed in my last commentary is still seemingly underway. U.S. retail sales data for October was up by a strong 1.7% and industrial production rose by 1.6% over the same month. While not having the finalized data, our models suggest November trends also to be positive.

Conversely, most other developed countries are now underperforming. For example, U.K. GDP rose by 1.3% (un-annualized) in the third quarter. However, this was a tepid showing relative to the prior quarter. It was impeded by a return of COVID-19 infections in the U.K., forcing many people to isolate at home once again. In addition, global supply chain problems have proven particularly acute for export-oriented economies including Germany, Japan, and Korea.

Inflation update

The latest global inflation readings remain high. The U.S. Consumer Price Index (CPI) in October rose 6.2% on a year-over-year (YoY) basis, the highest reading since 1990. Prices roses by a mammoth 0.9% over the past month alone. Core inflation is not so extreme, but has nevertheless now reached +4.6% YoY, with increasing evidence that inflation pressures have broadened out from their original drivers. As we had predicted in an earlier note, this is not transitory. U.K. CPI is now at +4.2% YoY and Eurozone CPI is +4.1% YoY. Japan is the only major developed nation bucking the trend (just +0.1% YoY CPI). To the extent that the developed world buys consumer goods from China, it is concerning to me that China’s Producer Price Index (PPI) rose at its fastest rate in 26 years in October: +13.5% YoY.

Supply chain improvements?!@

Supply chain problems remain an issue. However, patchy improvements are becoming visible. The number of container ships waiting to dock and unload their goods in Los Angeles and Long Beach has fallen (a key metric I follow). However, we hesitate to celebrate too much until my newly purchased furniture arrives…

Container ships at anchor or holding areas in Los Angeles and Long Beach

The cost of shipping goods around the world has also declined – incrementally for containers and quite sharply for dry bulk goods. The actual cost of shipping products is not usually a large part of a product’s price – and therefore is not a big inflation factor. However, insufficient shipping throughput has been a major problem for many industries during this cycle and so lower shipping costs should correlate well with easing supply chain problems.

Shipping costs falling but still elevated

As of 11/22/2021. Shaded area represents recession. Source: Baltic Exchange, Macrobond, RBC GAM

Southern California ports are getting serious about eliminating the backlog of unloaded containers waiting at their ports via the introduction of a new system of fines. However, to the extent there is a severe shortage of truck drivers and rail constraints, it is not clear whether this will significantly resolve the problem. Happily, several large retailers announced in their recent earnings reports that they had plenty of stock for Black Friday and beyond. It is hard to say the extent to which this represents genuine improvement, companies putting a positive spin on the situation, or perhaps even larger retailers outmuscling smaller ones for access to shipping.

Oil outlook

Oil prices have declined but are still high even by the standards of the pre-pandemic period. High oil prices were not expected to be a feature of the pandemic recovery, as demand for oil remains lower than it was pre-pandemic for obvious reasons: fewer people are commuting to office jobs and plane travel remains below prior peaks. But suppliers have proven slow to increase their production, resulting in a shortfall.

We continue to expect oil prices will fall further over the coming six months, for several reasons. First, the International Energy Agency forecasts that oil supply will rise by 1.5 million barrels per day over the remainder of 2021 – a significant sum. The Agency further expects that global oil supply will then moderately exceed demand for most of 2022. Additionally, in keeping with the historical experience after episodes of high energy prices, OPEC now predicts that recent elevated oil prices will hurt energy demand in emerging market countries such as China and India. Finally, financial markets certainly anticipate a further decline in oil prices, as per oil futures that are in an extreme state of backwardation. Backwardation refers to a situation in which the futures market anticipates a lower price in the future relative to the current market price.

With a focus on the U.S., oil production remains well below pre-pandemic levels. This implies significant latent capacity to increase output. Further, there is evidence that this is now beginning to happen, albeit gradually, given a rising rig count (see subsequent chart).

As of the week of 11/12/2021. Source: Baker Hughes, Bloomberg, RBC GAM

To be clear, none of this is a prediction of outright low oil prices. It is more likely that oil prices simply become a bit less high. And we must be particularly cautious in assuming that the supply response will be as eager as in the past given new headwinds. These include a more difficult fundraising environment for oil producers and fears of accumulating reserves that could later be stranded due to climate change mitigation efforts.

Scotsman’s View

The global economy has moderated, but growth remains quite good, and in our view, the economic cycle still has several years of expansion ahead. In this environment, interest rates remain low, but central banks are now contemplating reductions in their bond-buying programs before raising interest rates. We think that bond yields are likely to gravitate higher at a gradual pace. From current levels, even a slight increase in yields would result in negative returns for sovereign bonds. 

Overall, recent developments for investors are mixed, perhaps skewing slightly in a negative direction.

Positives include:

• The U.S. economy continues to grow after a lull.
• Supply chain problems have become a bit less bad.
• The Fed Chair will remain unchanged for another four years.

Negatives include:

• New Omicron variant cases rising globally.
• Non-U.S. developed and emerging nations appear to be suffering an economic deceleration.
• Inflation remains high and is no longer transitory.

Given this backdrop, we would remain overweight stocks as they continue to offer better upside potential. We recognize, however, that valuations are demanding and that continued robust growth in profits together with heightened investor confidence will be needed to keep the bull market going. For these reasons, we would suggest keeping a modest cash position to cushion against any volatility and to provide funds for opportunities as they arise.

ESG RESEARCH COMMENTARY

Why We Can’t Afford to Ignore the Importance of Natural Capital

As the construct of climate continues to be a topic of discussion and debate, so has its related jargon. The conversation of climate has now moved beyond carbon emissions and pricing to include the importance of natural capital. So, what exactly is natural capital? 

Natural capital is arguably the most important form of capital as it is fundamental in supporting human existence. Although it is interconnected to climate, natural capital refers to nature’s assets both renewable and non-renewable functioning as soils, oceans, fish stocks, forests, air, ozone layer, water, oil, gas, minerals and all living things that produce ecosystem services – benefits provided to people from our natural environment, notably food, water, carbon capture, pollination or protection from soil erosion or flooding. 

While the concept of natural capital was first introduced in 1973 by British economist E.F. Schumacher and has been mentioned every decade since, the climate conversation is becoming increasingly focused on the massive risk to both the environment and global economies if natural capital is not protected. In fact, according to the World Economic Forum, $44 trillion in economic value or greater than 50% of global GDP, is strictly dependent on nature. 

Biodiversity benefits crop pollination, water purification, flood protection, carbon sequestration, all estimated to impact global GDP by 1-1.5x, according to the OECD. Yet according to Schroders, humans have changed almost 75% of the earth’s surface, 66% of the ocean, destroyed half of the world’s coral reefs and put one million animal and plant species under the threat of extinction. That current level of biodiversity loss compares with previous mass extinctions which has happened only five times in the last 540 million years.  

It was reported that G7 leaders recently announced “our world must not only become net zero, but also nature positive, for the benefit of both people and the planet.” According to the Future of Nature and Business, a nature positive economy can unlock $10 trillion of business opportunities by transforming the three economic systems that are responsible for almost 80% of nature loss – food, infrastructure and energy.

Clearly nature plays a critical role in regulating our climate and enabling our economies to function optimally. Safeguarding and enhancing natural capital requires action by governments, corporations and individuals to improve ecological pliancy and heighten the benefits that our ecological system can provide to society at large. Therefore, we cannot afford to ignore its importance. 

Country Governance Research Commentary

by Matthew Zimmer, Head of Governance Research

ESG Trends – COP26 Outcomes

The 26th UN Climate Change Conference of the Parties (COP26), held earlier this month in Glasgow, concluded with an agreement among 200 countries on a new Glasgow Climate Pact as well as other significant international agreements. The commitments represent incremental progress, but they fall short of the steps that would be needed to meet the goal of limiting warming below 1.5C by the end of the century.  Highlighting the difficulty, India was joined by China in pushing at the last minute to water down a call to “phase out unabated coal power” and instead the final pact only agreed to “phase down” coal use.  Developing countries’ push for more resources to deal with climate change were also thwarted with only an agreement to pursue dialogue on the issue of compensation to developing countries for their climate change “loss and damages.”  Likewise, an earlier unfulfilled commitment by developed countries to provide $100 billion a year in finance to developing starting from 2020 was only addressed with an urgent plea that developed countries double their collective amount of funding by 2025.

More positive developments from the conference include the Global Methane Pledge, led by the U.S. and European Union, one hundred countries agreed to collectively cut methane emissions by 30 percent by 2030.  The United States and China also pledged to boost climate cooperation over the next decade in areas including methane emissions and the switch to clean energy.  There were also pledges by 140 countries representing 90% of global forestry agreeing to end and reverse deforestation by 2030.  The most ambitious efforts were led by Costa Rica and Denmark with a push to set an end date for national oil and gas exploration and extraction.  The Beyond Oil and Gas Alliance (BOGA) is comprised of nine countries and the state of California with a goal of the “managed phase-out of oil and gas production.”

Implications:  The climate activist, Greta Thunberg, remarked derisively that the COP26 event was so much “blah, blah, blah.”  While that assessment may be overly harsh given the myriad of challenges involved in stirring 200 disparate countries to collective action, it is clear that COP26 could best be seen as a step forward but not yet in line with the progress needed.  Furthermore, any success from COP26 rests on countries following through on their pledges for future action, so most important to watch for will be the actual implementation of commitments made.

Germany again delays the Nord Stream 2 pipeline

The Biden administration reached an agreement with Germany at the end of the summer to waive sanctions and allow the completion of the Nord Stream 2 pipeline.  However, opposition to the project in the United States and Europe has not waned, and new obstacles have delayed bringing the pipeline into operation.  In Germany, the regulator overseeing essential infrastructure suspended its certification process for the venture because of EU “unbundling” regulations, which require that companies producing, transporting and distributing gas within the bloc be separate entities.  Nord Stream’s request to be exempted from the rules was rejected by a German court in August.  Having to comply with the EU’s requirements will delay but not stop the pipeline.  Once the bureaucratic requirements have been met, the four-month certification will begin again.  The delay will push final certification into the next German administration with Olaf Scholz expected to take over as chancellor in early December.  Scholz has supported the project, so it is unlikely he will reverse the deal, but Green Party co-leader Annalena Baerbock, who is slated to be the next foreign minister, has advocated taking a tougher line with Russia.

Implications: Proponents of the pipeline had hoped the project would be operational in time to lessen shortages for this winter heating season, but that timeline will now most likely slip into mid-2022.  With tensions high over Russia’s renewed military build-up around Ukraine, in the interim opponents may find a more receptive audience for their concerns.  In the United States, there is a bipartisan push to include new sanctions on Nord Stream 2 as part of the must-pass annual defense authorization bill.

India scraps agriculture reforms in response to farmer protests

India’s parliament has passed a bill to repeal three laws that would have deregulated India’s agricultural markets.  On November 19, Prime Minister Narendra Modi announced his reversal on the controversial legislation following over a year of protests by farmers against the measures.  His capitulation was a rare climbdown by him and his Bharatiya Janata Party (BJP) led government, which has had an uncompromising reputation during its seven years in power.  The laws passed in September 2020 were aimed at modernizing agriculture markets by lessening the government’s role and opening more opportunities for private investors.  The current system introduced in the 1960s is recognized by all sides to be badly in need of reforms.  Close to 60 percent of the population depends on agriculture for their livelihood, but reflecting the vast inefficiencies in the sector, agriculture accounts for only about 15 percent of the country’s economic output.  However, the farmers were upset about the rushed process for passing the legislation and complained that they had not been adequately consulted.  The government tried to quell the protests, but the farmers were resilient and well organized, and their campaign ultimately prevailed.  

Implications: The timing of Modi’s decision was not coincidental.  With his standing having already been weakened by a variety of problems, including the government’s handling of the Delta Covid wave that devastated India earlier this year, he is hoping his concession will help win over farmers in Uttar Pradesh and Punjab ahead of state elections that will be held next year.  

Argentina opposition makes gains in mid-term elections

The ruling coalition of President Alberto Fernandez was badly defeated in mid-term elections, with his Peronists losing their senate majority for the first time since democracy was restored in 1983.  Half the seats in the lower Chamber of Deputies and a third of the seats in the Senate were up during this cycle, and when all the votes were counted the opposition won 42% of the national vote against only 34% for the Peronists.  Losing the senate majority represents a major setback for Vice President Cristina Fernandez de Kirchner, who as vice-president chairs the upper chamber.  She has been seen as an obstacle to the government’s efforts to secure a deal to roll over $45 billion owed to the IMF.  The debt comes from a failed IMF program agreed with the prior administration of former President Mauricio Macri.  The hope is that the election results will make it easier for President Fernandez to take the tough decisions necessary to come to a new arrangement with the IMF.  He has promised to send a long-term economic plan to Congress in December, which would include the initial understandings reached with the IMF.  

Implications: Pressure is building for Argentina to finally reach an agreement with the IMF.  Disbursements from the IMF have been frozen since 2019, and persistent fiscal deficits have been financed mainly by printing money.  The predictable consequence has been inflation of more than 50%, among the world’s highest.  Making progress on resolving the country’s economic problems will be critical to President Fernandez’s prospects in presidential elections to be held in 2023.