March 2023 market commentary

In March, we experienced a crisis in the banking industry after three US regional banks failed, and Credit Suisse was forced by central bankers and regulators to merge with UBS. The indices may not have changed substantially over the course of the month but price swings within asset classes and sectors have been significant. In the UK, the FTSE 100 lost 2.47%, whilst the Euro STOXX 50 index gained 2.01%. In the US the S&P 500 gained 3.67% and the FTSE World Index gained 3.09% over the month.

(All returns are sourced from FactSet and are reported as total return in local currency for the period 28/02/2023 – 31/03/2023).

Banking stress brings a mild recession closer

The collapse of Silicon Valley Bank (SVB) in the US sent shockwaves through the global financial sector, with tens of billions wiped off the value of some of the world’s largest banks. Despite regulatory interventions and reassurances from America’s President Joe Biden that people’s funds were safe, US bank stocks plunged in value. European and Asian equity markets also tumbled as fears over the fallout from SVB’s collapse rattled their banking sectors. Major government bonds rallied as investors bet that central banks would slow the pace of interest rate increases.

There are good reasons to be optimistic that a 2008-style systemic crisis in the banking system, and the very deep recession that followed, will be avoided. In contrast to 2008, today’s largest banks are well capitalised, so they have a lot more capacity to absorb losses. Credit Suisse's problems were about liquidity, not solvency – and the main purpose of central banks is to lend to solvent institutions suffering liquidity problems. We also do not see evidence of an economy-wide credit bubble or reckless lending to bad credit, like we did ahead of the Global Financial Crisis.

However, this isn’t a reason for complacency; banks have already begun tightening lending standards and with intensified investor scrutiny it seems highly likely that they will become even more cautious in their lending. This will only raise the (already high) risk of recession.

The exposure to banking within Greenbank portfolios is low. We have historically been wary of the banking sector given the opacity of its funding, not least of fossil fuels projects (despite many signing net zero pledges). The events over March have shown that there remain many unique and complex risks associated with the sector.

Bringing down inflation remains a priority

In recent months, financial markets have signalled that investors believed the Fed may stop raising rates by the end of 2023. But some stronger-than-expected economic data and continued uncertainty about how quickly inflation will retreat back towards central bank targets, has triggered a reversal in market sentiment. Though concern about bank stability complicates the outlook it appears that inflation, and therefore interest rates, may stay higher for longer. In the US, CPI was high enough in February to further complicate the path forward for the Federal Reserve, with CPI rising 6% year on year in the month, following a 0.4% increase in January. The Fed subsequently raised interest rates in March to a range of 4.75% to 5% – its ninth consecutive rate rise and the highest rate since 2007.

Despite speculation on 15 March that the European Central Bank (ECB) would shy away from interest rate rises in the wake of SVB’s collapse, it raised rates by 50 basis points. ECB President Christine Lagarde was keen to emphasise the separation between managing banking risk and raising the risk-free rate to fight inflation, sticking to the mantra that “inflation is projected to remain too high for too long” and describing its banking system as “resilient.” We saw a 25 basis point increase in the UK too, demonstrating how determined the Central Banks are to get inflation back under control. Inflation is likely to remain higher this year in the UK than elsewhere due to higher inflation expectations and weakness in the UK labour supply

Barriers to growth for China’s economy

Chinese growth is set to bounce back this year, following the scrapping of the zero tolerance COVID restrictions and policy turning more supportive. Yet the longer-term challenges facing China have not changed, and we think this cyclical rebound will eventually give way to structurally slower growth. Consumption is recovering after 2022’s lockdowns, but it is falling short of the more bullish estimates from economists and analysts, while consumer confidence surveys are still showing signs of weakness. On top of that, growing geopolitical tensions will make for an even tougher environment for foreign investors in China to navigate. China’s trend growth rate is likely to be much closer to those of advanced economies in the coming decade than the rapid rates it experienced in the 2000s and much of the 2010s.

Can we avoid 1.5C of global warming?

At the end of March, the Intergovernmental Panel on Climate Change, more commonly referred to as the IPCC, released the fourth and final instalment of the sixth assessment report (AR6). This draws together the key findings of the preceding three main sections and makes fresh recommendations to policymakers ahead of COP28. The report reiterates that the world is not on track to achieve either of the Paris Agreement’s temperature pathways – 1.5C and 2C – with stated policies likely to result in a 2.8C trajectory even if delivered in full. The crux of the calls to action are ultimately on “effective and equitable” climate actions, largely the rapid scaling-down of fossil fuels.

In order to give humanity the best chance of aligning with the Paris Agreement’s 1.5C pathway and avoiding the worst physical climate risks, the IPCC is calling for at least a sixfold increase by 2030 for finance provided to projects that reduce emissions. This will need to come from a mix of public and private finance, with a particular focus on directing funds to the global south. The money will need to be spent in line with scientific, local and indigenous knowledge rather than in line with the solutions that are most politically popular.

Investor stewardship must be swift and bold to respond to the urgency of climate action. This remains a strategic priority for Greenbank and we have ramped up our engagement with companies to support the achievement of our net zero by 2040 target. We set time bound objectives for priority companies in 2022 and have introduced a clear escalation strategy for us to follow if we are not seeing the necessary rate of progress. We have also extended our engagement on net zero to cover the externally managed funds we invest in and have joined the newly formed IIGCC’s Net Zero Engagement Initiative to allow us to engage collaboratively with other investors who share our commitment to aligning portfolios with net zero emissions. 

While engagement remains our near-term focus, we continue to integrate climate-related data into how we assess new ideas and review existing investments and are continuing to evolve this approach. This enables us to improve our identification of climate-related risks and opportunities, helps us focus engagement on priority companies and issues, and will allow us to ratchet up the minimum acceptable baseline for climate performance more accurately over time.

The money will need to be spent in line with scientific, local and indigenous knowledge rather than in line with the solutions that are most politically popular.

Our response to the UK’s ‘Green Day’

With 44 documents and almost 3,000 pages of policy guidance and government responses to consultations released on ‘Green Day’ on 30 March, we were hoping for a step-change in the UK’s ambition on climate change and the green transition. However, much of what was announced is simply repackaging existing commitments or new pledges with limited funding commitments to support them. Measures to speed up planning for solar arrays and offshore wind farms (including innovative floating wind farms) are welcome, but we are disappointed by a balanced review of planning rules for onshore wind.

The UK government’s response to Chris Skidmore’s Net Zero Review contains a number of commitments to establish consultations and roadmaps for the roll out of low carbon technology and infrastructure. While this is welcome, the IPCC’s recent synthesis report made it clear that we do not have the luxury of time if we are to avoid the worst effects of climate change.

A formal response to the US Inflation Reduction Act is expected in the Autumn, but Jeremy Hunt has noted that the UK is unlikely to compete with the US and EU on subsidies and tax breaks. Instead the focus is likely to be on incentivising private investment and fostering innovation and growth. There is a huge amount of financial capital waiting to flow into low carbon solutions but long-term, clear policy frameworks that underpin the net zero transition are needed to unlock this. 

Outside of the focus on climate change, we welcome the UK’s first Nature Markets Framework, which sets out principles for investing in ecosystem services for the first time. It also outlines measures to help scale the UK’s transition finance programme to support the transformation of hard-to-abate sectors and updates its environmental reporting guidelines on collecting and reporting Scope 3 emissions data. We would, however, like to see this being made mandatory.

Conclusion

Returning to the topic of recent banking turmoil, there may be good reasons to think that the consequences for the broader banking system can be contained. But we are remaining cautious. That turmoil is likely to damage confidence and hasten the tightening of bank lending standards. 

We expect ongoing market volatility in the short term as investors digest recent events, however we remain long-term investors, and therefore do not intend to make any significant changes within the portfolios as a knee-jerk reaction. We have been positioning portfolios more defensively over several months. We also have a natural underweight to the banking sector due to the sustainability focus of our portfolios, and therefore exposure to any ongoing impacts of recent events should be less severe. However, no diversified portfolio is immune to the ripples of market volatility as a consequence of these events.

We believe our focus on global social and environmental trends and challenges (such as climate change and the necessary transition to net zero) will be a major driver of returns in the future. Such an approach allows us to identify investments which will be resilient in the face of long-term sustainable development challenges and to manage the associated risks better. This investment case is brought into sharper focus by the latest IPCC report on climate change.