Must I do this? Must we? Well, if we must I reckon we must. I’ll tell you fairly that my heart ain’t in it. But I’m a market guy, and if one commits to the long-established protocols of markets, it is imperative that suppliers adhere to the prerogatives of those on the demand side of the equation, often energetically embracing its preferences – even when underlying premises evoke supplier doubt.
Consider the example of ESG, which the investment community is now enthusiastically and wholeheartedly embracing, while, in truth, the concept is being rammed down its throats. Now don’t get me wrong. Lord knows we’re probably be none the worse for embracing commercial activity that is sensitive to our environmental concerns, pays proper obeisance to social issues, and practices governance that meet the capricious standards of those who make it their life business to police the morality of others. But there’s a divine concept known as moderation, and it’s one we should all embrace.
But here I get ahead of myself. For the uninitiated, ESG is an investment concept that mandates the allocation of capital exclusively, or at minimum, disproportionately towards those companies which are deemed to be good actors with respect to virtues of Environmental Protection, Social Justice, and egalitarian Corporate Governance. ESG investing has now become something of a religious mantra among those heretofore tasked with simply chasing a decent return in the financial markets. In some sense, it fills the vacuum occupied a year or two ago by crypto, and more recently by cannabis. The first two have a kind of “if you can’t beat ‘em, join ‘em sensibility”. So, for that matter, does ESG, but in its case, with a dash of something even dearer than filthy lucre, an opportunity for holy redemption.
So ESG investment is on the charts with a bullet, and it looks like more than a one-hit wonder. A very high profile former boss of mine is forming an entire investment platform around the concept, and he’s not alone. Last year, Larry Fink: Founder/Chairman of Blackrock (which happens to be the world’s largest investment platform) sounded formal warnings to global corporate leaders that from here-on-in, they would be judged in large part on their ESG footprint, and he’s been doubling down on it ever since.
I’ve no particular issue with any of the above. Presumably, and as I learned at the University of Chicago, companies that act as good global citizens should most certainly be rewarded for so acting, as by the same logic, firms who behave poorly should pay a penalty. However, you must forgive me for holding dear to the impression that all of this was already built into the investment equation, and wanted little additional institutionalization to work its infallible logic. But when have we ever stopped at a reasonable point on our tortured journey towards perfect systems of moral risk and reward?
So it has come as an embarrassing surprise (I should have known earlier) to me that over the last couple of weeks, nearly one third of my clients have found themselves in something of an ESG focus vortex. Here, they must allocate significant resources away from the galactic task of making investment selections on the basis of such quaint anachronisms as profit profiles, balance sheet strength and growth prospects, to ensure that the investments that breach these narrow portals have passed at least minimal muster with newly-implemented, acceleratingly deployed ESG scoring systems. Institutional investors are now demanding this, and my best advice to my clients wishing to work with these entities is that they do what they can to accommodate their wishes. If pension funds, endowments, sovereign wealth funds and the like want to hold you to an ESG score, you are strongly advised to make it happen for them. It’s their capital we seek to manage after all, so in a very real sense, they call the shots.
However, and as I often inquire (rhetorically speaking) in these pages: what could go wrong?
Well, I’m just not convinced that this scoring system is going to be a particularly effective means of achieving the presumed objective of injecting stone-cold “wokeness” into Corporate America. A bunch of independent analysts are now running around and putting up ratings our publicly traded companies – all $50 Trillion of the market capitalization they represent, all I can say is good luck. These companies, it should be kept in mind, employ more than fifty million workers, operate in nearly all of the 195 countries around the world, produce and/or sell pretty much everything we buy, and, as a result and in aggregate, reflect the full measure of all human activity – divine and sinful – that transpires on this forlorn planet. I suspect that the ESG scoring systems will also, and equal proportion, reflect both our sins and redeeming thoughts and actions. Thus, if there is perceived benefit, sleight of hand will indeed ensue.
Yes, it strikes me that the whole scoring system is comprehensively gameable. If XYZ International wants to goose its Environmental rating, it can probably do so by the application of chicanery — at a lower all-in cost than actually burning lesser quantities of fossil fuels and removing pollutants. Consider, here, if you will, a couple of examples. Tesla is painting the automotive world in emerald hues, in part by consuming more electricity than namesake rival Thomas Alva Edison ever contemplated. The farm belt is all about ethanol, and the energy companies play along, but it still requires, on balance, more refined crude to produce the blended mix than are used when the grain-based middleman is eliminated and we just pour pure refined petrol in our tanks. How do the ESG scoring gods balance this in their equations?
To me, the same sort of thing applies to the S and G components of the formula. Put in some training and social awareness programs, but treat your employees and vendors like sh!t, and you’re probably OK. Throw a couple of mooks who fit the bill on your Board and forget to invite them to meetings, etc.
In fact, the whole thing starts to remind me of the College Admissions Scandal that was our biggest obsession this side of Jussie Smollett during the month of March. I imagine, even now, a handful of savvy CEOs paying specialists to game the ESG scoring system. A few dollars here, a couple of strategic hires there, and bam! ESG problem solved. The perp walks can wait for further discovery.
So the good news I have to share is that a new industry, which will require significant staffing, is on the rise. One of my clients told me that at a bulge bracket bank with which they work, the ESG scoring division is the largest hiring area on the whole enterprise. When we throw in the resources required for the ESG equivalent of enterprises run by this Bill Singer character (who has demonstrated, that for a nominal service charge, he can usher your lazy, empty-headed child into the hallowed halls of USC) , it’s no wonder that the March Jobs Report redounded to the delight of so many, and the consternation of so few. I won’t go into the details; suffice to state that it beat on every metric – except the over-watched hourly earnings estimate – by just enough to avoid concerns about overheating.
And it was not the only good news of the week. Domestic Manufacturing PMIs exceeded expectations, and even recently beleaguered domestic auto sales perked up to a robust 17.5M units. For these reasons and others, the Gallant 500 and its fellows put in their best week of what can only thus far be described as a boffo start to the year. And, improbably, published reports even suggest that hedge funds recorded their strongest quarter since the dark days of early ’09.
And now, somehow, the SPX is 48 skinny index points (1.63%) from its all-time highs registered in late September of last year. I. Am. Astonished. To. Even. Type. These. Words. I encourage my readers to mark the interval. Some of these days, and they might not be that far into the future, we’re all going to remember this period as one of wistful wonderment. I don’t want to keep singing the same note over and over again (even if does represent over half of my ~2-note vocal range), but if I review these tidings from the perspective of conditions around Christmas, I would have placed the probability of reaching this pass before the first blossom materialized on the Merritt Parkway at less than 2%. Maybe less than 1%.
There’s no particular reason, moreover, to think we’re done with this here rally. My experience suggests that when we get this close to a new high, investors feel duty bound to test it. I recall writing (and please don’t force me to prove it) early last year, as Apple and Amazon were approaching market caps of $1 Trillion, that their breaching of these thresholds was a near-certainty, because investors would not resist the temptation to see if such a thing was even possible. And it was. And they did. Both companies hit a tril. And both then retreated, along with the broader markets, in ignominious fashion. But they are each in range again, and who’s to say that investors won’t open the $1,000,000,000,000 door again with an open embrace? So, particularly in the small number of sessions between now and the bone fide commencement of the earnings season, there will be great temptation to see if the Gallant 500 can breach the 2940 level that represents its greatest point of penetration to date. Half a league, half a league, half a league onward, and we’re there. Whether our heroes can hold this ground, is, however, another matter.
Further potential upward catalysts largely derive from the meaningful possibility of a deal with China. I won’t go into too much detail here, but if these two big dogs do put paw to paper, I think that it’s probably worth another 500 index basis points to the good.
But mostly, as the month unfolds, all eyes will justifiably turn to earnings, and here’s where the problems begin to materialize. Everyone expects a weak quarter and tepid guidance. But everyone keeps buying anyway, and that, mis amigos, is a somewhat troubling paradigm. As may have been expected, much of the valuation frenzy resides in tech land, as illustrated below:
But it was ever thus, my loves. Our amorous eyes, once turned towards those bright shiny objects in the Silicon Valley, are always hard-pressed to ever look away.
It should, however and in closing, be noted that the darlings of tech use more electricity than any other sub-group in the economy, that many (AMZN, FB, GOOG) are in essence entirely controlled by their founders, that their global information flow monopoly is almost complete, and that the mitigants they have established for associated misuse are laughably and entirely optical. Moreover, inside those glittering corporate campuses, the free exchange, of, say political opinions is brutally suppressed. By way of example, and as covered in the WSJ, Google activists managed to toe tag an advisory committee on the ethical use of Artificial Intelligence one week after its formation, for having committed the sin of including a black woman who also happens to be the President of the conservative Heritage Foundation.
But Google’s stock is on the rise, and, like its peers down the road, it is also within shouting distance of a tril. The ESG cops apparently have either not caught on, or chosen not to act. Someday, perhaps, they will, though, so be forewarned. And while you’re at it, I wouldn’t throw away those financial models just yet either. Who knows, even in an ESG world, they may be of some use in the future.
TIMSHEL