Carbon Counter

1050 words – a 4 minute read.

What a week for the Climate fight… amid mudslides in Japan, floods in Germany and over 60 wildfires burning thru the American Southwest, Europe announced its Climate Plan including the 1st major upgrade to its carbon ETS in its 16 yr. history while China unveiled its national carbon ETS.

That’s not all; US reps spoke positively about Europe’s plans for a Carbon Border Adjustment Mechanism (CBAM) while several Senate Democrats mused about a possible US CBAM as a way to help pay for the Biden $3.5T Phase 2 Infrastructure Plan. Note that there has never been any support for the CBAM concept in the US so this is new ground - welcome new ground.

From our Tri Polar World POV, one speculates on the potential for the US and EU to join together in a common CBAM if they really wanted to isolate and impede China’s growth. Such an approach could really hurt China’s export effort given that the current carbon price in China is roughly a 10th of what it is in Europe and maybe 1/4th of what it is in California.

I believe this is one reason why China is moving quickly to put its own ETS in place - to reduce the geo political and geo economic strategic vulnerability its lack of carbon pricing has suddenly exposed.

The ability to shift climate mitigation from a cost to a benefit is one we will be hearing more about – as cities rep their green characteristics, companies do the same and see new business and new residents as a result. Is it unreasonable to think that countries will follow?

I don’t think so and expect Climate to be a main reason why Govts around the world will play  bigger roles in their economies than at almost any point in the last 40 years. Climate ensures the role of Big Govt is back. 

This is likely to be most visible in Europe which is set to become the global laboratory for deep decarbonization. This follows its green bond financing leadership, its ETS (largest by far though China’s will be larger over time) and its Green Deal and Joint Recovery Fund (JRF) linkages which sets up its medium term outlook to be the best of the TPW’s three main regions: Asia, Europe and the Americas.

All this of course is bullish for our overall thematic focus, our Climate focus in particular and within that our Carbon focus which will benefit from Europe’s ETS reform to accelerate the carbon price rise as allowances are reduced and prices hiked in coming years. 

If climate is this decade’s single largest global macro trend, carbon is one of its single biggest and best risk reward investments with noted consultancy Wood Mackenzie arguing a carbon price of $150 is needed by decade’s end to meet the Paris Accord targets. Climate remains the single biggest segment and Carbon the single biggest position in our global thematic model portfolio, the TPW 20.

Elsewhere the cross asset markets continue to churn around, chopping up traders and generally leaving many unhappy about their portfolios. While many warn of what lurks beneath, its worth noting that there is very little in the way of downside participation as most stocks range trade. Noted technician Marty Pring recently observed that the SPY/XLP relationship just cleared a major 10 yr. resistance level, suggesting further upside.

Speaking of climate, oil is the latest to see a healthy pullback with WTI at a 4 week low after its worst weekly price action and first back to back down weeks since March. XLE is now down 12% from its recent high and approaching most O/S levels since last Fall. This seems very similar to Copper’s 14% pullback which bottomed a month ago.

Its also illustrative of much of the cross asset price action over the past several months – a big move up and then some digestion and pullback within a fairly tight range as bubblets pop and pothole markets reduce the risk of big downside moves.

What will drive that next up move? As I wrote in my 2H Outlook I expect it to be the shift from staggered country reopenings to synchronized global expansion as we move thru the 2H and into 2022. 

The tactical issue seems to be the Delta variant spread vs the vaccine production surge – certainly in the media space it’s a blowout in favor of the variant… the clear nature of the variant spread should increase the urgency of vaccinations. This is the case in Europe which has virtually caught up to the US in terms of % of population vaccinated. Expect similar vaccination surges to occur in Asia and EM as we advance thru the yr.

Rates arguably hold the key – June’s big US inflation print gave the 10 yr. a chance to break thru its resistance level at 1.23%; it failed & now technicians suggest a move upside of 1.45% is needed to declare we are back to higher rates and the next leg of the Cyclical – Value, non US equity move. 

Polls showing that 59% of Americans see themselves as “thriving”,  the highest since GFC, reinforces the likelihood of continued solid US growth. China’s Q2 economic data supports a shift from peak growth to still strong growth with a nice spread of better retail demand and fixed asset investments. The PBOC’s recent RRR cut seems to have been more technical than strategic.

The trick is to note the shift from peak growth (already occurred in China, occurring now in US and later this yr. & into next in Europe, Japan and EMs) to still strong growth. Europe is well set up with its JRF just beginning to disburse; dual track infrastructure plan passage in the US will reinforce the US path while China has plenty of ammo should it need. The BOJ just raised Japan’s 2022 GDP & inflation forecast.

Choppy markets are never fun – bloody and bruised, with scraped knee and elbow, the investor, whether PM or DIY, needs to keep calm, observe what is happening and take advantage of opportunities when & where they present themselves while hopefully enjoying the summer months with family & friends.

TGIF!