By Derek Horstmeyer and Beau Fitzpatrick
The US is facing the lowest interest rates it has seen in its history – never has the 10 year Treasury rate been below 1% and never has the Federal Reserve pledged to keep interests rates low for years into the future.
And this single fact alone should have sustainable investors cheering. Low interest rates not only reward companies that are investing in clean tech solutions that pay off years down the road, but they also heavily penalize companies that may have stranded assets or other assets that will be liabilities in the distant future.
In other words, a natural consequence of low interest rates is that all investors have to be sustainable investors!
To expand on how this works – all institutional investors when evaluating the price of a stock, use some form of discounted cash flow analysis to come to the proper value of a firm. What this means is that they look at the predicted cash flows (or earnings) of a firm years into the future and discount each cash flow with the appropriate interest rate (or discount rate).
A near-zero interest rate environment means that the earnings a firm produces years into the future have nearly the same contribution to the value of the firm as the earnings produced today. Another way to say this is that investors really care right now about the earnings a company will deliver 25+ years in the future.
This is a really unique situation since even if interest rates were at the 4% level or above we would see an entirely different result play out. With interest rates at this level, investors will naturally care much more about the near-term earnings of a firm they are evaluating. This gives them an excuse to ignore possible stranded assets like oil wells and other liabilities a company may face in the future.
But this is not the unique world we are facing right now. The Federal Reserve has stated that interest rates will be near zero for a long, long time. And investors have adjusted their thinking accordingly.
Take the oil and gas giant Exxon for instance – just 5 years Exxon was the US’s largest company. Yet as interest rates have fallen (along with oil prices) Exxon has lost 50% of its value.
Even in the last 6 months as oil prices have gone up 12%, investors of all sorts have continued to hammer Exxon’s stock, to the tune of a -14% return over the same time period. Continued falling interest rates have forced investors to evaluate Exxon’s business model over the long term and to factor in oil wells that may stop producing in 20+ years as massive liabilities on the company’s balance sheet.
We see these low interest rates not only harming the valuations of oil and gas companies, but also helping the valuations of companies that are forward thinking. As the 10 year rate fell from 1.88% to under 1% since the start of the year, the average clean tech ETF has gained over 100% since the start of the year. These gains are more than any other sub-industry in the technology space this year.
With near zero interest rates here to say, even if you do not care one iota about the environment or saving the world through your portfolio choices, you will have to be a ‘sustainable investor’ if you care about the returns to your portfolio over the next decade or more.