Quarterly Market Currents: Geopolitical Discord Looms Large for Impact Investors
After an eventful third quarter, the American economic and geopolitical environment is poised for an even more consequential fourth quarter:
In markets, the welcome initiation of the rate-cutting cycle and today’s high-stakes election are brewing high potential for short-term volatility and creating uncertainty around notable impact investing-related government initiatives.
An uptick in Private equity-backed IPOs strengthens the prediction that private market liquidity will continue to loosen.
The overturning of Chevron Deference is poised to send shockwaves through the impact investing ecosystem.
Read on below for more on the currents moving markets in the fourth quarter of 2024.
The election heard ‘round the impact world
"Our experience as a responsible investor shows that financially material topics are evergreen because they relate to value creation and risk management, which are relevant to investors regardless of the political climate. While political debates may shape short-term policy directions, an investment program that incorporates analysis of material ESG issues aims to improve business resilience and foster innovation, not exclude businesses or interfere in their operations.”
-Calvert. “US Elections in the Spotlight: Responsible Investing Transcends Politics”, 10/16/2024
As we were drafting this quarter's comments, the US Presidential election loomed nearly a month in the future. By the time you read this, the election may have passed, in which case we'll have a lot more clarity on some of the questions we raise. Nevertheless, we want to be timely in delivering perspective on what’s at stake for impact investors.
A month out from the divisive November election, it is shaping up to be decided on narrow margins. Outcome projections aside, it is virtually certain such a polarizing geopolitical event will introduce short-term market volatility through the fourth quarter. Beyond that, there is far less certainty to potential market ripple effects from the two presidential candidates taking office. Potential impact investing-related ripple effects on the ballot are more clear:
SEC Climate Disclosure Regulations: Given Trump's track record on ESG issues, the SEC’s recently adopted climate disclosure standards are very likely to be jeopardized in the event of a Trump presidency. Conversely, a Harris presidency is expected to provide continuity to SEC initiatives established under the Biden administration.
Inflation Reduction Act: Similarly, some or all of the Inflation Reduction Act (IRA) may be in jeopardy under a Trump presidency. The broad-sweeping act has, interestingly, benefitted red states and districts the most, so a partial repeal is seen as the most likely outcome if Trump is elected. Funding for EVs, solar/wind, and hydrogen are seen as likely targets for repeal in this scenario.
As the election approaches, the stakes for impact investors are clear: political outcomes may stir short-term volatility, but the real ripples for the impact investing community lie in how future leadership will shape key impact-related policies. While a Trump presidency could unsettle climate regulations and clean energy incentives, a Harris administration would likely maintain current momentum. Amid the uncertainty, investors should remain steadfast in their portfolio's impact goals. It’s not about predicting the election’s outcome but positioning portfolios for lasting impact and value in an evolving geopolitical landscape.
The rate-cutting cycle has begun
“Fortunately for the economy and investors, the Fed finally found inspiration to start lowering interest rates this year, given evidence that (1) core inflation had fallen to within striking distance of the central bank’s annualized 2% target, and (2) the economy, especially the labor market, had weakened enough to set off recession worries.”
-Nuveen. “The race against recession: Was the Fed too slow out of the gate?”, 9/30/2024
In last quarter’s commentary, we touched on the teetering Fed decision to cut interest rates: at the time, inflation had just breached below 3% for the first time since 2021, and labor markets were starting to show signs of softening. These early signs of softening in the labor market supported the enticing possibility of a more accommodative monetary stance. This momentum persisted into Q3, with headline inflation dipping further to 2.5% by September. In turn, the Fed acted decisively, lowering interest rates by 50 basis points at its September meeting.
Source:JPMorgan
Financial markets applauded the news, with U.S. equities and global stocks gaining over 6% in the third quarter, while U.S. bonds advanced by more than 5% (according to Morningstar data). The rate cut, combined with a steady decline in inflationary pressures, has stoked optimism, with the potential for further monetary easing creating additional tailwinds for asset prices. However, key risks remain. The upcoming November election introduces the possibility of political uncertainty, and the labor market’s surprising resilience could limit the Fed’s flexibility to continue cutting rates. In the fourth quarter, we foresee the slow drip of dynamic economic and geopolitical developments (see next topic) poised to brew market turbulence.
Trickle Down From IPO Market Helping to Thaw Frozen Private Markets:
“We are seeing more fund managers explore exit opportunities for their portfolio companies, including strategic sales, sponsor-to-sponsor sales, IPOs and continuation vehicles. The key word is “explore.” Most managers we speak to are actively engaged in exit readiness programs for their aging investments but are still waiting for either 1) more clarity in the regulatory or political landscape in Q4 or 2) more favorable asset pricing that comes with lower interest rates and a risk-on investor mentality. Manager consensus is we are heading for a more favorable exit environment in 2025.”
-North Sky. “Accelerating into autumn”, 3rd Quarter 2024
The market for IPOs (initial public offerings) in the US is starting to see some renewed vigor after a slump following the COVID pandemic and the ensuing inflation/rising interest rates. According to Bloomberg, sponsor-backed IPOs (IPOs of companies with PE firms as major investors) are rebounding. While political instability, such as the current turmoil in the Middle East and the pending presidential election, can put a damper on IPO activity, the recent activity and positive pricing of these securities post-IPO is a positive sign for increased dealmaking in 2025.
Last quarter, we discussed the pervasive liquidity logjam stifling flows in private markets, which was showing early signs of loosening. Our prediction was that this loosening trend would continue, primarily as the US economy continued to thrive and as the case for a lower Fed rate became more clear. This recent uptick in IPO activity offers another sign of thawing in these frozen markets, confirming our thesis. IPOs from these large PE portfolios have a positive trickle-down effect on the private markets, including the relatively small, impact-focused, private companies and assets that Align clients invest in.
Picture the world of private equity as a waterfall with multiple tiers. At the top are the large PE funds, and when they exit their big investments, they release water to flow down to the next tier. With that capital freed up, these large funds can now buy slightly smaller companies, much like water rushing to the next level of the waterfall. As those mid-sized PE funds make their exits to the larger PE funds, they, in turn, purchase even smaller companies, passing the opportunity further downstream. Thus, increasing activity in the market for IPOs is another leading indicator of liquidity returning to private markets in the US.
Chevron Deference: An invitation to regulatory chaos
“On June 28th, the Supreme Court voted 6-3 to overturn “Chevron deference,” a longstanding precedent that compelled federal courts to defer to administrative agencies’ interpretations of statutes that Congress directed the agency to administer.”
-PWC. “Financial services regulatory update”, 6/28/2024
This seemingly innocuous decision carries profound implications for impact investing markets. By limiting federal agencies' ability to interpret ambiguous laws—such as the EPA’s authority on environmental regulations—the ruling diminishes agencies' power to protect essential aspects of public health. This change could weaken safeguards on the food we eat, the water we drink, and the air we breathe, as agencies may no longer be able to predictably and effectively enforce critical regulations.
We will share more in upcoming quarters as ripple effects become more apparent, and we will be closely monitoring these regulatory implications as part of our diligence process on related impact investing strategies.
Things We’re Reading
