Can sustainable stocks turn the tide and come back in favour?

The first half of 2022 has been a testing time for investors as the highest level of inflation for a generation has caused central banks to swiftly raise rates, increasing economic uncertainty and simultaneously reducing investor confidence and market valuations.

Stocks categorised as sustainable have been among the worst hit by this shift in market dynamic, leading to some calls that their investment case has significantly weakened, with strong prior performance dismissed as merely a result of the favourable previous market environment.

Long-term performance comparisons for sustainable stocks remain favourable

Source: Refinitiv DataStream 06/07/2022

Clean energy investment is a prime example of impressive growth in this field with the annual growth rate since 2020 rising to 12%, versus an average of 2% for the previous five years. Solar PV accounts for almost half of this investment and its attraction has been heightened further by soaring energy prices since the war in Ukraine began. Although the world’s oil and gas producers are set to double their net income this year due to higher prices, investment in fossil fuels remains below the levels seen prior to the pandemic. This could well begin to constrain supply, and if it does, it will apply upwards pressure to prices and increase the relative attraction of renewables.

What will a recovery look like?

Although inflation remains high there are some cautiously encouraging signs that suggest it could be close to peaking. The labour market remains red hot, but wage growth has begun to moderate and many commodity markets, including the oil price, have pulled back significantly from recent peaks. That is not to say that a recovery for growth stocks is imminent, but it is important to be aware of what driving forces to look out for that will suggest its likelihood of occurring has increased.

Demand, overall, remains fairly solid. Leading indicators of economic activity have begun pointing to a slowdown, but labour markets remain strong. Economic growth is expected to slow further, and the possibility of a recession has increased, but even if this were to occur there is little to suggest a deep and prolonged slump is likely. The chief cause of slowing economies is restrictive monetary policies, but even this is not expected to be sustained for the longer-term and derivatives markets are already pricing in interest rate cuts next year from the Federal Reserve. This point is key, economies are cyclical and even if there is a downturn, they will recover.

Investor confidence can lead fundamentals and gauges recently show this measure at low levels, historically speaking. However, this forward-looking feature still holds during recoveries and markets often bounce from lows before economies have begun to truly recover. What is more, the recent declines have seen many growth stocks return to more modest valuations, falling in some cases from fairly lofty levels. This is good news for investors, as the stocks have become cheaper and although they are not yet extremely cheap, they are certainly less expensive than they were.