4Q21 Letter: "The Path to a New Normal"
Business Update
During 2021, Evolve Investing experienced consistent growth, having more than quadrupled its total assets under management, and more than tripled the number of clients served. Over the course of the year, we helped our clients invest into numerous early-stage companies, venture and growth equity funds, and public companies that are taking actions to create a regenerative, more just, and healthier world.
To better serve our clients, we have enhanced our impact methodology through our partnership with Ethos ESG, a FinTech platform focused on conscious investing. Through this partnership, Evolve Investing now offers a broader array of investment causes, such as disease eradication, clean water access, supporting healthy oceans, and ending hunger. As an advisor to Ethos ESG - which recently completed a seed capital raise - I am working closely with the team at Ethos ESG as it expands its analytical tools and product offerings.
Evolve Investing remains focused on maximizing impact by moving more dollars into the causes that matter. In the near future, I expect to share some additional updates to our investment offerings for accredited investors. As always, I welcome any introductions to early-stage founders and impact investors aligned with our mission.
The Impact of Impact Investing
As more investors make value-aligned choices with their investments, companies are listening and responding. In 2021, there were a number of major changes at large corporations as a result of shareholder actions. Below are several examples of how large corporations responded to shareholder feedback and implemented more environmentally- friendly policies:
In April, the Net-Zero Banking Alliance was formed. Members of the alliance – which include Wells Fargo, Goldman Sachs, JPMorgan Chase, Morgan Stanley, Citibank, and Bank of America – are committed to aligning their lending and investment portfolios with net-zero emissions by 2050. The Alliance represents over 40% of global banking assets.
In May, hedge fund Engine No. 1 LLC waged an activist campaign against Exxon Mobil Corp., arguing that the company was underperforming financially as a result of its culture of climate change denial and its focus on fossil fuels.
Despite Exxon Mobil management’s staunch opposition, the campaign won support from large asset managers including Vanguard and BlackRock, as well as pension funds including CalPERS, CalSTRS and the New York State Common Retirement Fund. Ultimately, the company was forced to seat new Board directors that are focused on environmental principles with a lesser reliance on fossil fuels.
After committing to advance regenerative agriculture practices on one million acres of farmland by 2030, General Mills has expanded its program and compelled change across the sector. Today more than half of U.S.-based agriculture companies have a regenerative farming policy in place.
A number of major companies committed to lowering the use of plastic packaging. Specifically, in 2021 Target and Keurig Dr. Pepper agreed to reduce virgin plastic use in brand packaging by 20% by 2025, Walmart agreed to reduce its total virgin plastic use by 15% by 2025, and Mondelez agreed to reduce its use by 5% by 2025.
Economic & Market Update
As we enter 2022, above-average inflation and increasing COVID case growth remain pressing threats. I’ll address these concerns below, and share my more general views on the economy and stock market.
The COVID-19 pandemic remains the top risk to growth in the global economy, in my view. In November 2021, the Omicron variant was labeled a "variant of concern” within days of its initial discovery, resulting in immediate travel restrictions. Since then, we’ve seen increasing COVID cases globally, fueling concerns over an impact to economic growth. In the first week of January 2022, the U.S. added more than 1 million people to its COVID-19 case count, a single-day record for new cases for any country in the world.
While the headline COVID case numbers are concerning, the silver lining is that the numbers of severe cases and hospitalizations have not tracked case growth. A recent study from South Africa showed that Omicron-infected patients were 73% less likely to have severe disease than Delta-infected patients.
Importantly, following the discovery of the Omicron variant, we experienced a much faster global reaction when compared to the discovery and reporting of the Delta variant. After considering the incredible coordinated global response to this variant, and the numerous studies suggesting that Omicron is milder in nature compared to previous variants, my expectation is that any significant fears over Omicron are overblown.
In fact, my view is that we are now in a new phase of the pandemic, in which the spread of this milder variant leads to wider-spread immunity, and a creates a more direct path to endemicity and a “new normal.”
The second most pressing concern facing the market, as I see it, is inflation. In my 2Q21 letter, I discussed how the above-average inflation numbers we saw in early 2021 were largely concentrated in categories such as used cars and trucks, vehicle rentals, and airfares. In the second half of the year, inflation spread more broadly to other categories including food prices and wages.
The major takeaway is that price inflation may not be temporary, as originally anticipated, and instead could persist well into 2022. The Federal Reserve seems to agree, as days after his renomination by President Joe Biden, Fed Chair Jerome Powell conceded that inflation will likely be more sustained, and removed the word “transitory” from his prepared remarks.
As a result of higher inflation and solid job growth, the Fed has become slightly more hawkish, having formally announced that it is tapering its $120 billion per month pace of purchases of Treasuries and mortgage-backed securities (MBS). The Fed also opened the door to a 2022 increase in its target effective Federal Funds rate.
The major question on investors’ minds is, in this environment of rate increases and the withdrawal of stimulus, what are the implications for stocks and other risk assets? A recent study from NDR MacroEdge looked at the impact of Federal Reserve rate increases on stocks, and found that the S&P 500 rose an average 5.3% in the 12 months following the first increase when considering 17 policy tightenings since 1946. They also found that the pace of rate hikes makes a difference. The S&P 500 fell 2.7% on average during faster rate hikes vs. +11% during slow ones.
In light of these data, my sense is that the Federal Reserve can continue to utilize its policy tools as appropriate, and raise interest rates at a modest pace to combat inflation, without a significant negative impact on stocks and other risk assets. Importantly, the Fed clearly telegraphed the tapering of its asset-purchase program throughout 2021, and stocks remained resilient following its formal announcement in November.
Further supporting the equity markets – in my view – is the fact that a number of risks have already been priced into stocks, including the Federal Reserve’s more hawkish stance, the recent rise in COVID cases, any impacts from supply chain disruptions, and a slowdown in China’s economy.
Lastly, it’s worth noting that economic fundamentals generally remain strong, with the U.S. economy expected to grow 3.5-4.0% in 2022[1], S&P 500 companies expected to post earnings growth of 8.2% y/y[2], and more companies having demonstrated an ability to cope with issues like supply chain disruptions. With this strong economic backdrop in place, I’m feeling generally optimistic about 2022.My expectation is that the stock market will still provide solid financial returns in 2022, albeit at a more muted pace relative to the returns experienced over the last few years. I anticipate a return of 5-7% for the market overall in 2022, or 7-9% including dividends, a level that is more consistent with historical S&P 500 returns.[3]
Similar to the view expressed in my last quarterly letter, I continue to favor “value” stocks and “reopening plays” as more desirable areas of the market. While value and growth strategies ended up in a dead heat in 2021, value stocks are incredibly cheap relative to growth stocks, with discounts at near-historic highs.
Growth vs. Value Strategies in 2021
I expect value stocks to outperform in a rising interest rate environment, and view them as attractive relative to large-cap technology stocks which trade at higher valuations, are more interest rate sensitive, and have been viewed as “safer-haven” investments amid COVID fears.
The majority of Evolve Investing’s strategies are positioned with a bias toward value and small cap stocks, to take advantage of this opportunity. As always, you’re welcome to reach out to me anytime to discuss your portfolio and positioning.
In the coming days, you’ll receive your quarterly impact reports, which outline your financial performance as well as how your portfolio compares to market benchmarks with respect to the investment causes you’ve selected. Thank you for your continued support and confidence in Evolve Investing.
Best,
Peter Hughes, CFA
[1] https://www.barrons.com/articles/goldman-sachs-cuts-us-growth-forecast-manchin-51640001032
[2] https://insight.factset.com/industry-analysts-expect-sp-500-to-report-record-high-eps-in-2022
[3] https://www.berkshirehathaway.com/letters/2020ltr.pdf