The transition in 2024 - reality bites

Decarbonisation, supply resilience, affordability: is it possible to solve all three? The old adage of the transition trilemma (balancing all three components of energy policy) has come starkly into focus again over the last 12 months. To some, the energy transition seemed unstoppable. But throw in some post-pandemic supply chain issues, stubborn inflation, cost-of-living pressures, a hefty dose of geopolitics, and the juggernaut is starting to stutter. It's going to be a bumpy ride and investors need to understand the implications.

Decarbonisation in Europe

The pace of decarbonisation in the European energy system has been impressive over the last decade. Around 70 gigawatts of renewable generation capacity was added in 2023 - a 17% increase on 2022 - and the bloc is well on the way to exceeding its target of 42.5% of energy consumption from renewables by 2030. The UK has also made substantial progress in some areas, such as reducing the emissions intensity of electricity by 64% since 2015.

But since Russia's invasion of Ukraine there's been a noticeable rebalancing of attention towards energy security and affordability. This has become more pronounced over the last 12 months.

Energy security and affordability

In the UK, the wind industry's cost problems were brought into sharp focus in 2023, when there were no bids for the fifth round of offshore auctions. In the transport sector, cost pressures also led to a slowing of electric-vehicle uptake across Europe, and policies to ban the sale of conventional passenger vehicles have been pushed out.

The focus of policymakers, so far, has been firmly on decarbonising electricity generation, while other parts of the jigsaw have been neglected. This remains the case in the 'space and time' elements of the transition: getting renewable energy to where it is needed at the right time. This mismatch creates delays and adds costs for developers. The lack of storage, meanwhile, has led to periods of negative electricity prices and unused renewable energy. In order to retain system resilience, governments are forced to rely on gas-fired (or in some cases coal-fired) generation to do the hard work for longer.

Facing the reality

All of these factors add up to a slower decarbonisation pathway. The UK's independent Climate Change Committee has major concerns about the country's progress against targets. Some analysts now consider it highly likely that the 2050 net-zero objective will be missed. In Scotland, the recent scrapping of the country's 2030 climate target was the catalyst for the collapse of the coalition government's power-sharing agreement.

Similar patterns are playing out across the globe. Despite impressive progress, the energy transition is now facing some cold, hard economic and political realities. It's clear that the transition can't and won't happen without balancing energy security and the consumer's pocket.

Case study - biomethane in Italy

For infrastructure investors, we are used to navigating this complex situation to find opportunities to deliver long-term value for our clients. Our most recent investment in Italy provides an excellent example of combining the decarbonisation imperative with energy security and locking-in price certainty for the taxpayer.

The country is looking to produce 30% of its energy needs from renewables by 2030 and, in line with overall EU ambitions, to fully decarbonise by 2050.

With the support of the EU, the Italian government has decided to move away from using biogas for electricity generation. Instead, it's upgrading to biomethane to directly displace fossil gas in the grid. There's now a €4.5 billion incentive programme in place for biomethane in Italy. This is part of the EU's wider strategy to increase domestic production to 35 billion cubic metres by 2030. The strategy can support new biomethane plants, or the upgrading of existing biogas plants to produce biomethane, to reduce greenhouse gas emissions by at least 80% compared with conventional fossil gas. Importantly, the shift to incentivising more green molecules also reduces the country's reliance on imported fossil fuels.

We established a partnership with Blu-H Energy, which has unrivalled knowledge of the market. It is helping us identify small-scale opportunities and build our platform. But not all sites are equal. There are several crucial criteria we consider when selecting appropriate sites. First and foremost is the control of feedstock. It's not like installing solar panels in a field and waiting for the sun to shine. These plants need large quantities of inputs like manure and other agricultural waste. Securing this at the right price and quality is a key determinant of success.

We like rolling up our sleeves and getting involved in this type of investment. Taking our time, getting to know a sector, and building the right relationships on the ground is how we create the opportunities and risk-adjusted returns for our clients.

Final thoughts...

The energy transition is at a crucial point. There's a recognition that it won't happen at any cost and a rebalancing towards resilience and affordability is underway. This creates complexity for investors. But as exemplified by the case of our biomethane investment in Italy, sometimes it's possible to tackle all three of the trilemma's imperatives at once.

Author: Ruairi Revell, Head of Sustainability, Infrastructure

We have semiconductors snatching the sector title in equities as penny stock activity also rise in the US (not so much in Australia; and no mention of GameStop here, sorry). B2B SaaS growth moderates - as have tech EV/Revenue multiples - and strategists are now looking at strong US corporate earnings growth - will it drive capex or will it fall short itself as demand cools? The Atlanta Fed's GDP indicator has certainly dropped in recent days. Over in the US bond market, we are witnessing possibly the longest ever drawdown. Meanwhile, the Federal Reserve last held rates steady for over a year in the lead-up to the global financial crisis. Finally, we take a look at Starlink satellite customer numbers scaling up and the varying productivity chasm between small and large enterprises across nations.

Semiconductors emerge with the heaviest weighting in the S&P 500

Source: FactSet (via @jessefelder)

Share of US equities volume accounted for by "penny" stocks (trading at <$US1 a share)

Source: Financial Times

Estimate of ex-S&P/ASX 300 volume relative to total ASX volume

Source: Equitable Investors, Iress

Net new sales for all "B2B" SaaS companies on ProfitWell Metrics since Jan 1, 2022 (seven-day growth rates, seasonally adjusted)

Source: ProfitWell

Technology sector EV/NTM (next 12 months) revenue multiples

Source: Mostly metrics

Strong S&P 500 earnings growth as lead indicator for capex spending 

Source: Apollo Chief Economist (BEA, S&P. Haver Analytics)

Evolution of Atlanta FedNow GDPNow real GDP estimate for 2024 Q2

Source: Atlanta Fed

US Bond Market in a drawdown for 46 months

Source: Creative Planning, @CharlieBilello

One precedent for the Federal Reserve undertaking a long hold

Source: Bloomberg

Starlink customer ramp-up 

Source: ARK

Productivity of "Micro-, small, and medium-size" enterprises relative to larger firms by country

Source: McKinsey

June 2024 Edition

For the 16th consecutive month, property prices across the capital cities have risen, with CoreLogic's Home Value Index reporting a 0.8% increase for the month of May, the largest monthly gain since October 2023. The regions also continue to experience growth, with a combined 0.6% increase.

Perth continues to be the highest performing market, increasing by a whopping 2% for the month, with Adelaide and Brisbane also recording strong growth of 1.8% and 1.4% respectively. Sydney, Canberra and Melbourne also experienced growth for the month, increasing by 0.6%, 0.5% and 0.1% respectively, whilst only Hobart and Darwin recorded a reduction in dwelling values, of 0.5% and 0.3% respectively.

The RBA is scheduled to next meet on the 18th of June. Whilst we believe a further increase to interest rates is unlikely, the undersupply of new housing and low tenancy vacancy rates should, in our view, ensure property prices remain strong regardless of the RBA decision.

Clearance Rates & Auctions week of 2^nd of June 2024

Property Values as at 1^st of June 2024

Median Dwelling Values as at 1^st of June 2024

Quick Insights

Investor's Rush

Loans in the investment property market spiked in April, new home loan commitments to investors jumped 5.60% from March, the fastest rate of gain since November 2021.

Commonwealth Bank senior economist Belinda Allen said,

"There's no end to price impacts from the lack of supply and strong demand. It's economics 101″.

Source: Australian Financial Review

Australian Apartments Up Again

There has been a 26% national increase in apartment selling prices, primarily benefiting higher-end developments, this surge alone is driving the rise in new home completions to 28,000 this calendar year. This figure marks the highest in four years, compared to the previous total of 32,000.

However, Urbis director Mark Dawson emphasized that without a corresponding decrease in borrowing or materials costs to make lower-priced unit projects financially feasible, the current spike in completions might taper off in the future.

Source: Australian Financial Review

Author: Filippo Sciacca, Director - Investor Relations, Asset Management and Compliance

Despite the predictions of exit polls and contrary to market expectations, the 2024 Indian parliamentary elections saw Prime Minister Narendra Modi's Bhartiya Janta Party (BJP) secure only 239 seats, falling short of the 272 needed for a majority. This was a significant decline from the 303 seats the BJP won in the previous 2019 elections. The National Democratic Alliance (NDA), the political coalition led by Prime Minister Modi's BJP, still managed to secure 291 seats.

With crucial support from pre-alliance partners in the states of Andhra Pradesh and Bihar, the NDA is set to lead the government. However, it will be a coalition government with a smaller margin. On the other hand, the opposition Indian National Developmental Inclusive Alliance (INDIA) has made unexpected gains, securing 234 seats, while the Indian National Congress (INC) nearly doubled its seat count to 100.

The BJP's allies will now have greater bargaining power, which could extend to cabinet decisions and crucial reforms. This means the BJP will need to include its allies in important decision-making processes. Prime Minister Modi's government may now have a reduced majority but Indians have voted for his government for a third term, signalling a desire for policy continuity and continued reform momentum.

Election outcome indicates rural distress, need for large-scale job creation

The post-result analysis suggests that voters are discontent with issues like unemployment and inflation, and a more populist manifesto may have carried greater appeal. India's growth story remains resilient, but there seems to be a disparity between household consumption growth and real GDP growth. In the post-pandemic period, India has been witnessing a K-shaped consumption recovery, with demand from the affluent or premium segment doing well and with demand for entry-level and mass-market goods remaining subdued.

The lower end of the income pyramid has struggled following the pandemic and limited fiscal support has amplified the situation. To widen benefits from economic growth and reduce income disparities, India, in our view, will need a broad-based recovery in the capex cycle as construction is the largest generator of jobs outside of agriculture. We believe that the government will have to focus more on job creation and expanding the manufacturing sector while maintaining its focus on infrastructure development and digitalisation.

Government spending may change, but fiscal situation unlikely to deteriorate

The Indian economy has seen growth led by investments, partially encouraged by government initiatives, while consumption has lagged. The election outcome could result in a partial reorientation of government spending. However, we still believe that the government will maintain its focus on macroeconomic prudence.

There could be a shift towards subsidies at the expense of some capex, but we do not see a significant impact in the near term nor any deviation from the interim fiscal deficit target of 5.1% of GDP. If government reflationary policies are enacted as a result of political necessity, this could result in slower fiscal consolidation. Supply-side reforms are likely to continue, while factor market reforms may prove difficult to implement.

India's fundamentals remain strong

India's economic fundamentals remain robust. Reforms in India have generally survived political challenges, and we expect the government to maintain the pace of governance and administrative reforms. However, the more complex reforms involving land and labour need greater consensus building.

Therefore, while near-term uncertainty is high and the political backdrop is slightly different, the broad direction of reforms and macroeconomic factors remains unchanged. We continue to remain very positive on the longer-term potential of the India equity markets.

With Prime Minister Modi sworn in on 9 June, the immediate focus is on government formation and the political jostling between and among parties. The cabinet now has some new members from coalition partners. We will focus on the final budget, which is most likely to be put together early in July, to assess the policy direction.

The first 125-day agenda of the new government will be a key event that will set the direction of economic reforms. We believe that the agenda will focus on digitalisation, infrastructure, industrialisation and governance-related reforms.

Focus on companies with sustainable returns undergoing positive fundamental change

In the short term, the Indian equity markets are likely to be volatile. However, now that the election uncertainty has been resolved, we believe that over the medium term, there will be a strong corporate capex and credit cycle. In addition, a multi-year buildup in domestic savings is expected to funnel into equities and potentially provide a further boost for consumption.

From a longer-term perspective, this could be an opportune time to assess quality business franchises in India. We continue to focus on companies with high free cash flows, low balance sheet leverage and high return on capital. Currently, we have a favourable view on sectors such as financials via large private sector banks, consumer discretionary via the automobile sector and communication services.

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The "Grandfather" of Behavioural Economics

In late March, psychologist and economist, Daniel Kahneman, passed away at the age of 90. His work with Amos Tversky and others helped to establish the field of behavioural economics, including explaining cognitive biases and heuristics, and developing Prospect Theory. In 2002, Kahneman was awarded the Nobel Memorial Prize in Economics "for having integrated insights from psychological research into economic science, especially concerning human judgment and decision-making under uncertainty". Kahneman also wrote best-selling books including Thinking, Fast and Slow.

Kahneman's insights in the world of trading highlight biases such as overconfidence, herding behaviour, and loss aversion. His work is highly relevant for trend following managers, whose quantitative systems seek to exploit market inefficiencies. In this article, we provide a brief taste of some of Kahneman's work and how trend following is consistent with his elucidation of human behaviour.

The Reflection Effect

One aspect of Kahneman & Tversky's seminal Prospect Theory is the Reflection Effect, which describes how people's appetite for risk changes when we think about the same decision focusing on gains or focusing on losses. Kahneman and Tversky demonstrated that people are risk averse in the domain of gains, and risk seeking in the domain of losses. For example:

• A positive "gamble": given the choice to take $900, or take a 90% chance to win $1,000 (mathematically the same outcomes), people will generally tend to take the $900. It can be explained through the lens of the psychological value of the certain outcome being worth more to people than the prospect of winning $1,000. That is, an extra $100 doesn't seem worth the risk of getting $0

• A negative "gamble": given the choice of losing $900, or take a 90% chance to lose $1,000 (mathematically the same outcomes), people will generally tend to take the chance. Here we see the inverse (or reflection) of the positive gamble - the psychological value of potentially losing nothing is worth more than the risk of losing $1,000 instead of the $900. That is, the additional $100 loss doesn't seem to outweigh the potential positive of losing $0

That is, people will tend to take a risk to avoid losses, and will avoid risks to lock in gains. They will even make different decisions based on how a problem is framed.

There are studies around breakeven effects which further show risk seeking in the domain of losses. Experiments were conducted where people were studied at horse tracks, and found that punters placed riskier bets (longer odds) towards the end of the day, when they were on average already making losses - that is, they tried to win back their losses to break even. We can see this effect in force when investors hold on to losing stock market trades, hoping they will go back up to break even, or even take on riskier trades to try to win back losses.

Trend following systems are designed to overcome the Reflection Effect. Where human psychology instinctively has us locking in gains, trend following systems let profits run. When human psychology tends to steer us to take bigger risks to avoid losses, trend following systems are designed to limit losses through consistent and unemotional stop loss levels.

Emotions vs Rationality in Markets

Although those of us who are schooled in the field of Finance are taught the Efficient Market Hypothesis - that asset prices reflect all available information, behavioural economics highlights the role of emotions in decision making. Cognitive biases such as overconfidence, herding, information bias and loss aversion may help to explain market bubbles / "irrational exuberance" as well as "over-reactions" contributing to market crashes.

For example, Kahneman and Tversky found that people will typically extrapolate broadly from narrow data sets, which they called the Law of Small Numbers. To illustrate this effect, consider:

• tossing a coin three times to find it lands on heads each time - one might extrapolate that it is more likely to land on heads in the future, but

• tossing a coin a very large number of times shows us that overall the odds are 50/50 of a heads or tails result.

We can see that this cognitive bias may result in flawed decision making, and irrational market behaviours.

Trend following systems are designed to attempt to exploit irrational market conditions, and to avoid cognitive biases through systematic approaches to trading. Our strategies at ECCM are tested over long term, deep and broad data sets to avoid information biases and enhance objectivity.

At our website and our YouTube channel you can view our video "Embracing Objectivity Through Systematic Trading", in which ECCM's founder and CIO, Adam Havryliv, and Strategy Ambassador, Richard Brennan, talk more about our approach to statistical analysis and how we seek to avoid cognitive biases. 

Conclusion

Daniel Kahneman and his colleagues developed highly influential and insightful studies which have helped to explain human behaviour and in turn market dynamics. We recognise his work and the impact he had on our understanding of financial markets.

At ECCM, our educational foundations are in finance and psychology. With extensive trading experience and long-term dedication to quantitative trading systems, we seek to provide our clients with our carefully developed approach to navigating the complexities and vagaries of markets.

Wholesale clients can find more information on ECCM and our flagship ECCM Systematic Trend Fund at our website and Australian Fund Monitors.

Travel and holidays are important to many people as they represent a break from the norm, a chance to escape mundane reality and experience something exciting and possibly exotic. They are a chance to reconnect with family and friends away from the stresses of daily life and can provide significant benefits for our physical, mental and emotional health.

The forced lockdowns imposed during the pandemic era reinforced the value of holidays for many of us, and in our view there has been a meaningful shift toward experiences that cuts across generations. So much so that in a time when the cost of living has risen dramatically, rather than cutting back on holidays people continue prioritising their importance.

Having normalised significantly during 2023, international tourism is well on track to return to pre-pandemic levels in 2024, underlining why we feel this ongoing Future Quality investment trend is still worth pursuing.

Successful recovery of global travel

For the last couple of years, the global travel industry has been going through the process of normalisation following the pandemic-imposed restrictions that brought worldwide travel to a halt. Planes were grounded, accommodation closed and staff were laid off or siloed; consequently, the sector's recovery has taken time to rebuild to its former scale.

This normalisation has taken place against a backdrop of strong consumer demand. As lockdown restrictions were lifted, many consumers were eager to rebook holidays that had been either cancelled or postponed. The unleashing of this pent-up demand meant that, according to the UNWTO World Tourism Barometer, international tourism reached 88% of pre-pandemic levels in 2023.

As investors, we were quick to spot the investment opportunity that the normalisation of travel would represent. But now the recovery appears to be almost complete, it is time to reconsider the ongoing strength of this investment theme.

Ongoing growth drivers

Our analysis has determined that there remain several key ongoing drivers of growth for the travel industry. Firstly, while the market expectation that demand has now normalised seems fair, we found that one key factor is largely being ignored: the re-emergence of the Chinese outbound traveller. COVID-19 lockdowns were in place for a lot longer in China than anywhere else in the world and therefore travel restrictions have only just been fully lifted. Given the significant size of the Chinese population, the process of restoring the operational outbound capacity for flights will take time to reach its former scale and demand was initially subdued amid lingering concerns over COVID-19 and tepid economic growth. Yet, the importance of Chinese travellers should not be underestimated. In 2019, they represented the world's largest share of outbound tourists, contributing around US$250 billion to the global economy. Signs are positive that Chinese travel will rebound this year, with domestic trips over the China Lunar New Year holidays increasing 34% compared with 2023 and marking a 19% rise on 2019 levels. Travel and tourism have also been highlighted as the best-performing elements of China's otherwise lacklustre economy.

Chart 1 - Number of outbound Chinese tourists (in millions) 

Source: Bloomberg, April 2024.

Secondly, a new travel cohort is emerging from developing countries - India as a prime example - where rising gross domestic product per capita means more people will be able to afford to travel in the future. While this also includes China, it particularly encompasses the wider Asian region and has resulted in UK airport Heathrow increasing its forecasts of passenger numbers this year due to the growth in Asian routes.

Finally, artificial intelligence (AI) is being embraced by the travel industry initially to enhance the booking experience for flights, accommodation and car hire, as well as boosting call centre efficiency. However, going forward, AI applications could encompass advertising strategy, marketing content and greater personalisation.

Another factor to consider is supply and demand. Given that the demand is clearly there, it would be expected that at this stage of the cycle new accommodation would be being developed at an aggressive rate. However, due to concerns around commercial real estate and higher borrowing costs, that supply growth is not coming through, and is creating further inflationary pressures on overall holiday prices.

Future Quality Finders

Having discussed and reviewed our investment thesis around global travel, we still need to apply our Future Quality lens to find the companies that will attain and sustain rewarding returns not only today but, more importantly, for tomorrow.

In our view, many quality companies are directly benefitting from the positive tailwinds in global travel, from booking companies to manufacturers of luggage and travel accessories. We currently favour Booking.com, Amadeus and Samsonite.

Focusing on luggage manufacturer Samsonite, having re-engineered its manufacturing footprint and streamlined its costs during the pandemic, we felt its management did a good job of positioning the company for more profitable growth in the future with brand equity and pricing power largely intact. We expect the ongoing recovery in travel, particularly among business travellers, will continue to drive revenue growth and, with a lower fixed cost structure, the business has the opportunity to earn margins somewhat higher than the traditional norm.

By seeing further and envisioning the investment opportunities of tomorrow, we aim to invest in not only what is, but what will be. Contrary to popular perceptions, we anticipate that global travel will endure as a long-haul investment journey.