What is the issue?

Donald Trump is not known for being progressive on sustainability issues. He has previously promised to withdraw US participation in the Paris climate accord. But in terms of markets, what are the potential implications across sustainability themes from his second term in office? 

Climate

There have been concerns that the Inflation Reduction Act (IRA) will be one of the first things to go. But we don't expect a full repeal; reforms are most likely. This is partially because the IRA mainly benefited red states (see below). It's also because Trump is pro-energy and investment, but he's agnostic on the energy source. He has pledged to increase oil and gas licences on federal land, which could happen quickly through an executive order. This also increased under Biden, but the rate is likely to accelerate. 

Investment in clean tech by voting district* during the Biden Harris Administration as of 10.31.24

$42B - Democratic districts | $161B - Republican districts

Source: Bloomberg Opinion Article, Biden Is Giving Red Districts an Inconvenient Gift: Green Jobs, Published June 20, 2024, accessed 06/04/2024.

*Colour represents the voting of the 2022 House Representatives Elections.

Investment in Republican (red) and Democratic (blue) districts pre and post the Inflation Reduction Act

We expect that the US will withdraw from the Paris climate accord again. This won't happen at COP29 next week, but it will likely affect the US's ambition at the talks. 

During his campaign, Trump promised to end the "EV (electric vehicles) mandate", even though no such federal mandate exists [1]. We think a rollback of Biden's pro-EV policies, including sections of the IRA that incentivise EV production and adoption, are likely. On the surface, this would be potentially negative for his strong supporter Elon Musk who owns Tesla. Tesla's scale and scope could be an advantage over other EV producers if subsidies were removed. Tesla's stock was up almost 15% on Wednesday 6 November. 

Reforms to the IRA we think are likely:

*This one is highly complex and could go either way. On one side, continued funding will be highly lobbied by the energy sector. But on the other, Trump is not pro big-government and large tax-payer-funded projects, especially those with low technology readiness. Therefore, we are cautious. However, the funding mechanism that flows through the EPA could become an issue. As the agency's funding is likely to be cut significantly, this will make the final distribution of the funding slow.

We also expect increased tariffs on imported clean tech (especially EVs), but not at the level Trump has stated.

Nature 

The Biden administration strengthened several nature-related regulations, like the Endangered Species Act, and pollution regulations. These should be safe in the short term, as they are unlikely to be an initial focus area. But the likely defunding of the EPA will take the teeth out of the regulations. Alongside the overturning of the Chevron deference (which gave federal agencies powers to interpret laws and decide the best ways to apply them), this will severely weaken the powers of the EPA.
One area that benefited under the last Trump administration was the superfund (the fund set up to help remediate the nation's worst polluted areas). There are clean-tech names working in remediation that could benefit, such as Tetra Tech, if a similar thing happens in his second term.

Social

This could become challenging for corporations, as they were previously pressured by employees to make statements opposing government stances during Trump's first administration. Diversity, equity and inclusion are likely to be at risk. Investors looking for greater transparency and action are also likely to face increased scrutiny.

Abortion rights were a key campaign topic, but this was more likely to see change under a Harris administration. Given the Republican win, the dynamics of the Supreme Court, and Trump's stated view that abortion rights should be decided on at a state level, we don't expect federal changes. Additional states might implement bans that could lead to repercussions for women's health and wellbeing, and their productivity in the workforce. Interestingly, abortion protections were on the ballots at this election and in many states these passed. Investee companies have faced pressure via resolutions tabled at annual general meetings (AGMs) to refuse employee healthcare benefits to those seeking abortion.

A unified Republican Congress is likely to pass the H.R 2 bill. This would require employers to verify whether employees have the legal right to work in the US. If passed, the bill is likely to reduce the undocumented workforce and the flow of new arrivals into the US. It's therefore probable that the migrant workforce will be smaller under Trump, resulting in a negative shock to the labour market.

Governance

This year, the Securities and Exchange Commission (SEC) introduced new rules mandating company disclosures on climate-related risks. Under a new Republican SEC chair, we expect these requirements to be removed. The SEC also eased restrictions on resolutions at AGMs, leading to a surge in proposals advocating for environmental, social and governance (ESG) issues - particularly climate and employee rights. This has been met with 'anti-ESG' resolutions questioning the allocation of resources to ESG matters and political advocacy, such as women's health rights. The new rules were not unanimously supported and could be reversed, potentially resulting in a rise of 'anti-ESG' resolutions at AGMs. We do not anticipate significant changes to board standards.

Final thoughts

The initial reactions affecting clean-tech stocks are subtle. The trajectory and implications for sustainability and specific stocks will become clearer once the administration's nominations are announced. 

Author: Ann Meoni, Senior Sustainable Investment Manager
Nick Gaskell, Sustainable Investment Manager
Nancy Hardie, Sustainable Investment Analyst
Andrew Mason, Head of Active Ownership

¹https://www.factcheck.org/2023/10/trumps-misleading-claims-about-electric-vehicles-and-the-auto-industry/

Globally, equity markets were weaker in October. In the US, the S&P 500 declined -1.0%, the Nasdaq fell -0.52%, whilst in the UK was down -1.54%.

In Australia, the All Ordinaries Accumulation index declined -1.33%. On the ASX, the top performing sector was gold, supported by a +5% rise in the gold price. Banks also performed well in the month. Consumer staples were the worst performer, impacted by index heavyweight Woolworths (WOW) falling -10% following a weaker than expected 1H25 trading update.

In bond markets, the US 10 year government bond yield rose +50 basis points (bp) to close at 4.28%, whilst its Australian counterpart increased +53bp to end the month at 4.51%. The main driver of the higher bond yields was market expectations of less interest rate cuts from the Federal Reserve.

Iron ore prices may have finally found some stability moving forward

Recently, the People's Bank of China (PBOC) rolled out its most significant set of monetary easing policies since 2015. These measures were designed to address China's ongoing property sector challenges and provide a broader boost to economic growth. Interest rates and reserve requirement ratios have been cut to historically low levels, signalling the government's commitment to maintaining liquidity and preventing a deeper slowdown.

While this has spurred a rally in both Chinese equities and Australian resource stocks, the question remains: Is this a short-term sentiment-driven bounce, or the start of something more sustainable?

While opinions may vary on the longevity of this rally, one thing is clear: China's looser monetary policy has created an environment ripe for further fiscal and property policy adjustments. The current positioning of the market is quite negative on China and thus underweight stocks that are exposed to China such as Australian Resources. This helps explain the recent strong market reaction.

Have iron ore stocks found their floor? 

The common reaction to China's slowdown often involves calls to sell big miners like BHP (ASX: BHP) and Rio Tinto (ASX: RIO). However, that kind of knee-jerk reaction doesn't align with a value-based investing approach. While sentiment undeniably influences short-term market movements, the real question is: How much steel is the global economy demanding, and what is the marginal cost of supply?

At current prices, iron ore is likely sitting at a support level, hovering around US$95/t, which is underpinned by break-even costs. Prices have dipped below US$95/t for only 16 days this year, compared to 50 days over the last three years. The cost curve supports this level, as many producers would be unprofitable at lower prices. Additionally, trader mentality tends to kick in once prices break the US$100/t threshold, adding further support to this range.

On a more fundamental level, we believe there is currently around 120mt of supply in the market that requires a price of over
US$90/t to stay profitable. 

So, the question we have to ask is whether China's economic weakness is severe enough to remove another 120Mt of iron ore demand from the market. We don't think so. 

While the Chinese government has signalled its willingness to address demand concerns through coordinated policies, the China Iron & Steel Association (CISA) has projected that crude steel production will remain flat year-on-year in 2024. This suggests stability moving forward at current levels.

Supply-side adjustments: Rebalancing the market

On the supply side, significant cuts in iron ore production from both India and China have already done much to rebalance the market. India's output has fallen from 70Mtpa earlier this year to 30Mtpa due to price sensitivity, while China's domestic production has similarly dropped from 200mtpa to 80mtpa on a 62% Fe basis. 

In Australia, we have seen Mineral Resources (ASX: MIN) shut down the Yilgarn operations (8Mt) and the Sino Iron Project decreased from 21Mt to 14mt. These adjustments further underscore the market's price elasticity.

The greatest long-term supply risk remains the Brazilian mining giant, Vale. Although Vale has increased its production guidance for the year, Brazilian exports typically flatten out in the final quarters of the year due to seasonality, so massive increases in output are unlikely. 

Longer term, another potential supply-side disruptor that has long spooked the market is the Simandou project in Guinea. The rail line is expected to be operational by Q1 2026, with the port to be staged thereafter. The complexity of the project poses a significant risk of delays. We expect the operation to ramp up through 2028. Additionally, the wet season in Guinea introduces challenges with stockpile management and moisture control. 

For now, the risk of an oversupply glut in the iron ore market seems overplayed by the bears in the market.

Seasonality and Sentiment

Another factor working in iron ore's favour is seasonality. Historically, iron ore prices have shown strength from December through February, as China's domestic production falls during the winter months. This forces the country to rely more on seaborne supply, which is often disrupted by wet weather conditions in Brazil and the Pilbara region in Australia.

Port inventories are currently sitting at 150Mt, which is on the higher end of the seasonal average. However, this doesn't pose a significant threat to the market, as a portion of these inventories are now controlled by major iron ore players for blending purposes. 

Moreover, low-grade discounts have narrowed, and rebar spreads have rebounded from their September lows, signalling that much of the bearish sentiment may already be priced in. It is also difficult to assess the full supply chain inventories in China including stockpiles at steel mills. Recent discussions with China companies suggest that this inventory may be at the lower end of history.

Where is the opportunity in iron ore equities? 

In terms of equities, Fortescue Metals Group (ASX: FMG) is a recent addition to the portfolio. It offers an attractive entry point, and its lack of gearing makes it a pure play on a rebound in iron ore prices while paying an attractive fully franked distribution. BHP and Rio Tinto offer more diversified exposure, with their base metals businesses providing some downside protection.

While the market remains cautious due to weak Chinese sentiment, the fundamental factors supporting iron ore prices--cost support and seasonality--paint a more optimistic picture. 

As long as demand holds and supply remains in check, iron ore prices are likely to stabilise around current levels, if not rise slightly through the remainder of the year. Given this, an overweight position in iron ore equities, particularly FMG, appears to be a solid investment in the months ahead.

Is this the start of a larger rotation out of the banks into the miners?

We are seeing a significant valuation gap between the Bank and Resource sectors. The Banks sector has surged to an all-time high P/E of 18.4x (refer to Figure 1), well above its historical average of 12.8x, even exceeding the +1 standard deviation level of 14.5x, indicating stretched valuations.

Figure 1: ASX200 Banks - trading at 18.4x forward concensus earnings (all-time high)

Source: Factset

In contrast, the Resources sector is trading at 12.1x forward earnings (refer Figure 2), below its long-term average of 13.3x, making it the cheaper of the two sectors to own, which can be expressed through owning quality businesses like the iron ore majors. The stretched bank valuations have likely been partly an expression of the market being underweight China and resources given bank earnings have largely been in line with expectations. 

Pristine asset quality and extremely low bad debts have been the prime drivers providing some modest earnings growth. The obvious catalyst for a bank correction was either via the resource's rotation from confidence in a China recovery or the potential of a recession in either Australia or the USA. The former is emerging, and the latter is a realistic, albeit not a base-case scenario.

Figure 2: ASX200 Resources - trading at 12.1x forward consensus earnings (below LT average) - cheapest sector

Source: Factset

Author: Tom Hays, Research Analyst