The IIF’s research lays bare the economic disruption that will confront equity investors during the initial phases of the green transition. Inflation could be more volatile over the next five to seven years than it has been for much of the time since the financial crisis of 2008, remaining above central bank targets in many countries. GDP growth, meanwhile, will trail the long-term average as the gains in productivity that will come from investment in green technology are unlikely to materialise until the latter stages of the journey to net zero.
The lacklustre growth and erratic inflation brought about by the net zero transition could weigh on corporate profitability and, ultimately, dividends and shareholder returns over the next five to seven years.
No two sectors of the equity market will experience the economic effects of net zero in the exactly the same way.
A decline in households’ disposable income will result in lower aggregate demand and a fall in company revenues. Add to that a rise in businesses input costs and the burden of more stringent environmental regulations, and the conditions are in place for a steady but persistent contraction in profit margins. Factoring this into our models, we find that annual returns from equity markets will, in aggregate, be in the low single digit range in inflation-adjusted terms through the remainder of the 2020s.
But the broader picture masks wide divergences across countries and industries. No two sectors of the equity market will experience the economic effects of net zero in the exactly the same way.
One important conclusion to draw from the analysis is that the US stock market might lose much of its effervescence. That is a view we have held for some time and for several reasons. But clearly, the considerable cost of net zero for the world’s largest, and most carbon-heavy, economy is a primary factor. US companies will find that policy measures such as the pursuit of green technology self-sufficiency and more punitive carbon pricing will crimp profits. In the absence of financial transfers from the developed to the developing world, emerging market equities could also struggle, particularly in countries that are reliant on fossil fuels.
Consumer-facing firms are also susceptible to declines in household spending. Expect their share prices to underperform the broader market. Energy companies that are slow to transition and face the prospect of owning stranded assets are also vulnerable.
By contrast, shares of companies operating in the materials sector should fare well as demand for green metals and other commodities outstrips supply. Industrial and semiconductor firms supplying infrastructure and equipment critical to the net zero transition can also be expected to deliver market-beating investment returns.
