IMPACT COMMENTARY

Governance First

The world is now once again witnessing the horrors of war, of genocide, and the criminal actions of Russia against the Ukraine. These  images splashed across our media tell the story of an authoritarian who lacks the morality of dignity, and of governance gone wrong. The pain and heartbreak that has been captured in film and photo represent the many confounding events that are painted across our media daily.

For us at Newday, the Ukrainian/Russian tragedy has reinforced the fact that governance, both country level and corporate, really does matter. We have for years excluded Russia from our country allocation and as such, avoided what was a collapse of their financial markets brought on by the invasion of Ukraine. Other countries led by authoritarian regimes remain largely excluded from Newday’s portfolios. 

Over the past few years, we’ve come to understand that we are not as invulnerable as any other big empire from the past, and we have sat on a decadent pedestal of infallibility for some time. We are no stranger to the environmental and social consequences of poor governance and deployment of a solid system of checks and balances.  Whether it be the ill effects of the last Presidential election, the consequences of climate change, mass shootings that occur with regularity, or homeless populations living on America’s streets, we’ve all come to understand that THIS is not just “over there” anymore. All of these examples represent what can go wrong when governance processes fail.

Being responsible members of the community, supporting companies that are responsible stewards of precious resources, our environment, and of our workers, is work that every leader, every individual,  and every organization should be pursuing. This responsibility is also a shared challenge for corporations, faith based organizations, non-governmental organizations, and government. Each one of these entities play a critical role in providing the necessary foundation for a fair, free, and transparent global society. All of these stakeholders play an essential part in improving economic and social conditions throughout our world.

As an example, climate change affects traditional faith-based organization’s missions to improve human health, mitigate poverty and redress social inequity. Faith based organizations have been driven to advocate for clean air and water, restore ecosystems and conserve resources as a result of their recognition of climate change’s impact. They have committed to do something about it, and they’ve recognized that their efforts are tied back to the health of our environmental and social structure, and their own missions.

There are many organizations that do incredible things for our communities, but too many that don’t. Sometimes, these organizations are led by naysayers who have powerful roles in government and industry and for their own reasons, have chosen to either put their heads in the sand or selfishly profit. They often stand in opposition to social and environmental change. And these naysayers contribute to the white noise, banter, and chatter, which works against progress.It is our intention to work proactively in educating the uninformed, and engaging where organizations need support in getting to a more positive place. At Newday, we continue to fight to improve impact outcomes through our investment management and corporate engagement work, and through our support for some of the world’s most impactful nonprofits and NGOs. 

Q1 2022 GLOBAL EQUITY OUTLOOK COMMENTARY

“The war between Russia and Ukraine and the global response to the conflict are evolving rapidly, with the trajectories of economic growth and financial-market performance being significantly altered from just a month ago. Although we continue to think that the most likely outcome is for the global economy to continue expanding, we now expect slower growth with higher inflation, and we presume that the odds of recession have now increased.” — Gordon Telfer, Chief Investment Officer, Portfolio Manager (The Scotsman)

Geopolitical tensions flare up 

Russia has delivered on its threat to go to war with Ukraine and the invasion has opened up the possibility of a drawn-out period of uncertainty. While there are potential paths to a resolution if Ukraine and NATO agree to Russia’s demands, an agreement seems unlikely at the time of writing. From an economic perspective, Ukraine’s economy has been devastated and Russia is being subjected to harsh sanctions limiting flows of money, goods, and technology. Aside from shock and revulsion from this unprovoked aggression, the main near-term impact on the rest of the world is through lower supplies and higher prices for commodities, which will be most harmful to European countries given their reliance on Russian energy. We project a 0.7% reduction in the Eurozone’s 2022 GDP growth to 3.0% and a 0.3% decrease in U.S. growth to 3.1%. From a long-term perspective, the Russian-Ukraine war brings a range of potential implications including a new Cold War, increased defense spending, nuclear proliferation, and a heightened motivation for countries (particularly in Europe) to accelerate the shift in energy supplies toward renewables.

Global economic recovery slows 

Although the pandemic continues to gradually recede and both consumer and business spending is rising, the impact on growth is much less pronounced than it was a year ago. Moreover, a tightening of financial conditions, slowing Chinese growth, reduced U.S. government spending and elevated inflation were already working to undermine the economic expansion prior to the Ukraine conflict beginning. As a result, our forecasts for 2022 have moved somewhat lower from last quarter and remain below the consensus. We forecast global growth is set to decelerate to 3.5% in 2022 from 6.2% in 2021. Developed-world growth should fall to 3.0% from 5.1%, while growth in emerging markets is set to slow to 4.3% from 7.3%. It is worth noting the significant uncertainty around these forecasts given that the damage from sanctions on Russia is particularly unclear. As a result, we believe the risk of U.S. recession in late 2022, early 2023 is significantly higher, at somewhere between a 25% and 50% probability.

Higher inflation for longer 

Inflation is running at its highest levels in several decades, now above 7% in the U.S. and Europe while approaching 6% in other nations. The main drivers are surging commodity prices (energy in particular) and supply-chain disruptions, but smaller factors include still accommodative central banks, wage growth and a housing boom in much of the world. Inflation is likely to rise even further in the short run, due to the war in Eastern Europe. Offsetting some of these inflationary forces, over the next year, might be any easing in supply-chain pressures and the economy-dampening impact of central-bank rate increases. Taken together, we anticipate high and above-consensus inflation for 2022, but with a decelerating trend during the second half of the year. We continue to believe that inflation ultimately will, over a longer-term horizon, eventually fully revert to normal, with aging demographics and slower population growth even bringing inflation down below historical norms.

Currency landscape altered by Russia-Ukraine conflict 

The currency landscape has been altered by the freezing of Russian foreign-exchange reserves following the country’s invasion of Ukraine. The short-term impact of the conflict has been a stronger U.S. dollar as investors seek the safety, security and liquidity associated with U.S. assets. But the longer-term consequences of the war, which include higher commodity prices and a reluctance among countries to accumulate reserve assets, may create headwinds for the greenback. In this environment, we expect that commodity currencies could become the clear winners and the U.S. dollar may weaken.

Central banks respond to inflation pressures 

The war in Ukraine may ultimately reduce the amount of monetary tightening that would have otherwise taken place, but this year is still expected to be one when most developed world central banks move ahead with rate increases to temper inflation. We look for four 25-basis-point rate increases from the U.S. Federal Reserve (Fed), the Bank of England this year and none by the European Central Bank given the economic outlook for the region. Based on our historical analysis, we estimate that four rate increases theoretically reduces a country’s economic growth by 0.5% over the following 18 months – far from a recessionary impact. However, the speed at which central banks flipped to tightening mode presents at least some risk to economic growth and capital market returns.

Recent jump in yields moderated near-term valuation risk, but the long-term direction for yields likely remains up 

Rising rates and higher inflation pushed bond yields sharply higher at the start of the year. The U.S. 10-year yield rose more than 50 basis points to above 2.00% between the end of November and into the end of the quarter. We believe the hit to growth from the Ukraine war will continue to boost demand for safe-haven assets, pulling yields lower near-term. However, our models continue to suggest that the long-term direction for yields is higher, mostly since real, or after-inflation, interest rates are unsustainably low at -2.8%, their lowest level in 60 years. While there have been a variety of global GDP headwinds to real rates ranging from aging global demographics to lower potential growth rates, to an increased preference for saving versus spending, even placing them at 0% would provide substantial upward pressure on nominal bond yields. We recognize there are some war–related risks to economic growth that could temporarily limit the increase in yields, but our expectation for higher nominal yields over the longer term sets up a scenario where sovereign-bond returns are low or even slightly negative for many years.

Stocks enter correction, improving return potential if earnings come through 

After a strong 2021, global equity markets tumbled in the first two months of 2022 as major indexes experienced declines of 10% to 20% from their recent peaks. The broad-market S&P 500 Index finished the quarter down over 5%. A major concern for equity investors at the start of the year was the prospect of tighter Fed policy, prompting a significant cut to the valuations of the market’s most expensive companies. While the war in Ukraine is causing stock-market volatility, economic growth and earnings are forecast to continue rising, albeit at a slower pace. The consensus of analysts’ estimates continues to evolve higher (see chart below). Analysts’ expectations for the S&P 500 are for 8% profit growth this year, so there is still a decent cushion against the uncertainty. Moreover, given that measures of investor sentiment are extremely pessimistic, and valuations have come down, any indication that the outlook is improving could result in a significant positive upswing in investors’ attitude toward stocks allowing markets to move higher.

Source: PSC Macro

Scotsman’s Outlook Spring 2022 

The distribution of potential return outcomes spans an unusually wide range due to the war, surging commodity prices, leading to high inflation levels and a tightening of financial conditions via global central banks. We recognize that the odds of a negative return scenario for equities have increased meaningfully. Within the spectrum of possibilities, our base case continues to look for an extension of the global economic expansion, a peak in inflation by the end of the year and continued central-bank interest rate hikes. With this backdrop, the significant re-pricing in equities, since Russia’s invasion of Ukraine, has reduced equity valuations and therefore boosted return potential, assuming that solid nominal GDP growth will continue to support gains in corporate profits. From a portfolio allocation standpoint, we would continue to underweight fixed income given our longer-term view that the asset class will deliver low to slightly negative returns as yields rise. We would selectively add to equity exposure given the recent pullback, during the first quarter, and the potential for upside assuming our base case scenario plays out. 

ESG RESEARCH COMMENTARY

Oceans and the Blue Economy

Throughout history, different types of economies have emerged due to the changes and challenges resulting from the industrial age. Each economy transformed socioeconomic conditions with some given names based on colors. Such an economy is the Blue Economy. The World Bank defines the Blue Economy as “the sustainable use of ocean resources for economic growth, improved livelihoods and jobs, and ocean ecosystem health”. 

Our five oceans encompass 71% of the earth’s surface and roughly 97% of all its water. It is the largest continuous ecosystem on our planet and is so vast that oceanographers estimate that only 20% of it has actually been explored. Yet, we do know that the ocean provides a wealth of resources and welfare to our global population. From food, energy, minerals, health, leisure, and transport, oceans influence many interconnected industries. The United Nations (UN) estimates that over three billion people depend on marine and coastal biodiversity for their livelihood. One report by the World Wildlife Fund (WWF) estimates that global ocean assets to be $24 trillion (US$), with the annual value of goods and services at $2.5 trillion, making it 5% of GDP and the 7th largest economy if it were a country. In fact, the Organization for Economic Co-Operation and Development (OECD) projects those numbers to be closer to $3 trillion by 2030, which appears to be conservative given current figures.

Source: Reviving the ocean economy, WWF

But what most don’t realize is that all water on our planet is interconnected. The water that goes down our drains or runs off from our yards eventually makes its way to our oceans. That also means chemicals and plastic pollution makes its way there too. It is said that we generate 300 million tons of plastic waste annually with over eight million tons entering our oceans. According to a recent report done by the WWF, the number of plastics entering the world’s oceans could triple by 2040 and quadruple by 2050, with research suggesting that the amount of plastics will outnumber the amount of fish if we don’t do something about it. Since plastic never decomposes, it ends up contaminating and damaging natural habitats and wildlife, and once entering the food chain, could ultimately negatively impact human life. 

Climate change is another major threat to our oceans. The ocean regulates and stabilizes our climate and absorbs 23% of annual CO2 emissions generated by human activity and 90% of the excess heat in our climate. The ocean also produces anywhere from 50-80% of the earth’s oxygen. However, increased carbon emissions and deforestation have not only warmed our planet and water temperatures but induced ocean acidification and caused increased degradation and biodiversity loss which has severely impacted the health of our oceans. 

Overharvesting and destructive industrial fishing practices also threaten ocean health. The UN’s Food and Agriculture Organization noted that one-third of fish stock worldwide is experiencing depletion due to this, so the notion of a thriving Blue Economy is both compelling as it is complicated because its growth has a tendency to jeopardize the vulnerabilities of a robust and sustainable marine ecosystem. It took centuries to get to the current state of our oceans, so the blue economy is a concept meant to be a long-term strategy within the ocean industry intended to support sustainable economic growth while also preserving the environment and improving the well-being of our human existence. 

Our goal at Newday is to invest in companies that are at the forefront of providing solutions, whether that be through products, services, operating activities, and capital expenditures that positively contribute and amplify a healthy ocean and blue economy. We have also partnered with EarthEcho International, a nonprofit 501c3 organization founded in 2005 by siblings Philippe and Alexandra Cousteau in honor of their father Philippe Cousteau Sr., son of the legendary explorer Jacques-Yves Cousteau. EarthEcho collaborates with youth around the world to provide knowledge and develop tools that drive meaningful environmental action to protect and restore our ocean planet. Reaching more than 2 million people in 146 countries, they support the next generation to become environmental leaders who will transform the future. For more information about Newday’s Ocean Health Investment Portfolio or our partner EarthEcho International, please visit Ocean Health Portfolio | Newday (newdayimpact.com) or EarthEcho International.

“Working together we can change the current course of our oceans and chart a sustainable future.” ~John Kerry

Country Governance Research Commentary

by Matthew Zimmer, Head of Governance Research

Russian invasion of Ukraine enters second month 

Russia’s plan for a lightning strike on Kyiv and a quick capitulation of the Ukrainian government collapsed shortly after the invasion began with the fierce resistance of the Ukrainian army preventing the Russian troops from overtaking any major cities.  In response, the Russians have resorted to massive standoff bombardments of cities across Ukraine.  In the southeast of the country the city of Mariupol, in particular, has felt the brunt of the Russian onslaught with the majority of the city having been reduced to rubble and thousands of civilians estimated to have been killed.  Ukraine’s 10th largest city before the war, Mariupol had fought off an earlier assault in 2014, and it has been a key target as an unoccupied city in the Donbass, whose capture would allow Russia to create a land bridge between Crimea and mainland Russia.  The city has been encircled since the early days of the war and cutoff from any possible reinforcements, but the city has yet to fall thus preventing the Russian troops besieging the city from being redeployed to bolster Russian efforts that have been flagging in other parts of the country.  Russian troops have recently withdrawn from areas they occupied around Kyiv in order to refocus their efforts in the east of the country leaving behind widespread destruction and evidence of likely war crimes.  

Implications: There have been several inconclusive rounds of peace talks between Ukraine and Russia, but there are doubts as to how seriously the Russians are pursuing these efforts.  Complicating these talks is the possibility that Putin may not be getting a true picture from his advisors and may not fully understand the state of his forces in Ukraine.  For their part, the Ukrainians have offered to forego NATO membership in exchange for alternative security guarantees, but they are looking for ironclad assurances following the failure of the 1994 Budapest Memorandum.  Whether Western powers would agree is an open question. 

Chinese companies face US delisting for lack of auditing disclosure

The Securities and Exchange Commission has placed a first group of Chinese stocks on a watchlist for potential delisting from U.S. exchanges after failing to meet financial disclosure requirements.  The SEC’s notice begins a three-year countdown for the companies to come into compliance with the 2020 Holding Foreign Companies Accountable Act (HFCAA).  The law was introduced after Luckin Coffee, the largest coffee chain in China, was found to be fabricating its sales records.  The HFCAA requires companies to allow the Public Company Accounting Oversight Board (PCAOB) to examine their audit working papers and to disclose whether a foreign government owns or controls them.  Companies whose audit papers cannot be accessed by the PCAOB for three consecutive years will be delisted.  While six companies have been identified so far hundreds more Chinese companies are expected to face the same deadline.  Chinese regulators have long restricted foreign regulators access to company data out of fears that they could access sensitive intellectual property or data that carries national security implications.

Implications:  According to the PCAOB, more than fifty international jurisdictions have so far allowed their organization to conduct inspections with only China being an outlier in blocking access.  In order to prevent potential delistings, the China Securities and Regulatory Commission (CSRC) has published a draft rule for public consultation that if adopted would allow U.S. regulators access to company audit files.

South Korea opposition conservative party wins close election

South Korea narrowly elected Yoon Suk-yeol from the opposition conservative People Power Party (PPP) as its next president following a contentious campaign that commentators dubbed the “unlikeable election”.  Yoon entered politics only last year after having been the country’s top prosecutor who, among other high-profile cases, led the prosecution in 2018 of the country’s last conservative president, Park Geun-hye.   Yoon defeated Lee Jae-myung from the ruling left-leaning Democratic Party by less than one percent, or about 250,000 votes out of the 44 million votes cast (a 77% voter participation rate).  The outgoing president, Moon Jae-in, could not run again because the South Korean constitution limits presidents to one five-year term.  The campaign largely centered on domestic issues, including corruption and housing prices.  Yoon advocated market-led approaches to spurring economic growth, while Lee promoted more government spending on policies such as a universal basic income and compared himself favorably to Bernie Sanders.  Yoon also called for a more hawkish foreign policy and a tougher stance on North Korea in contrast to the Moon administration’s pro-engagement approach.  

Implications: In his acceptance speech Yoon promised to make national unity a priority after a divisive campaign.  When he takes office in May, he will need the support from his opponents, who retain a legislative supermajority in the National Assembly, to be able to pass any legislation.  Yoon who lacks foreign-policy experience will also have to deal with challenges from North Korea, which has recently renewed tests of long-range missiles.

Argentina reaches a deal with the IMF

Following approval from Argentina’s congress and the IMF’s Executive Board, the government of Alberto Fernández has secured a 30-month extended fund facility arrangement to restructure the country’s $44bn in debt outstanding to the IMF.  The debt is the amount remaining from a record $57bn that Argentina borrowed from the IMF in 2018 under the previous government of Mauricio Macri.  The failure of the IMF’s biggest ever bailout had left the country with an unsustainable debt burden, and this new deal will remove the threat of default on $19bn of repayments due to the fund this year.  Now that the program has been approved Argentina will immediately receive $9.7bn of funds, which will allow it to make its upcoming payments to the IMF including a $2.8bn instalment that was due just days after the agreement was finalized.  Under this new arrangement repayments to the fund would begin in 2026 and end with full repayment by 2034.   The conditions of the arrangement do not call for any significant structural reforms such as an overhaul of the pension system or changes to labor rules.  The agreement does call for reducing energy subsidies and eliminating central bank financing of the treasury, a major driver of inflation, to zero by the end of 2024.  Future payments from the IMF will be dispersed following quarterly reviews of progress on meeting the program’s requirements.

Implications: With a divided and unpopular government facing elections in 2023, maintaining political support for the program will be a challenge.  Further complicating the picture is the fact that inflation in Argentina is already one of the world’s highest at over 50% in 2021, and food and energy prices are rising sharply following Russia’s invasion of Ukraine making the targets laid out in the IMF arrangement even more challenging to meet. 

Disclaimer: This commentary is provided for information purposes only and is not an offer or solicitation of an offer to buy or sell any product or service. Unless otherwise stated, all information and opinion contained in this publication were produced by Newday Funds, Inc. (“Newday Impact”) and other sources believed by Newday Impact to be accurate and reliable. Due to rapidly changing market conditions and the complexity of investment decisions, supplemental information and other sources may be required to make informed investment decisions based on your individual investment objectives and suitability specifications. All expressions of opinions of the financial markets, general investment strategy, or particular investments are not recommendations to clients and are subject to change without notice.

Investors should seek financial advice regarding the appropriateness of investing in any security or investment strategy discussed or recommended in this report and should understand that statements regarding future prospects may not be realized. Past performance does not guarantee future performance.