Charles Hamieh, Nick Langley and Shane Hurst at ClearBridge Investments discuss the outlook for 2023.
Experts at ClearBridge Investments expect bond yields to push higher heading into 2023, before abating along with inflation later in the year.
For equities, contracting multiples driven by higher bond yields have characterized the first part of this bear market, they said in a statement.
The second phase of bear markets is generally an earnings recession, and they expect that to be a force, particularly in early 2023. However, the firm thinks that the impact on infrastructure to be muted, particularly for regulated assets, where the companies generate their cash flows, earnings and dividends from their underlying asset bases.
They expect those asset bases to increase over the next several years. As a result, infrastructure earnings look better protected to them when compared with global equities, they continued.
Most infrastructure companies have a link to inflation in their revenue or returns, they said. Regulated assets, such as utilities, have their regulated allowed returns adjusted for changes in bond yields over time. As real yields rise, utilities look poised to perform well, and they have currently tilted their infrastructure portfolios to reflect this. As a result, changes in inflation and bond yields don’t generally impact the underlying valuations of infrastructure assets. However, they have seen equity market volatility associated with higher bond yields impact the prices of listed infrastructure securities, making them more compelling when compared with unlisted infrastructure valuations in the private markets, they added.
The investment perspective comes at a time when a mix of market volatility, elevated inflation and rising interest rates have forced wealth managers to re-think their asset allocation strategies after years of ultra-low rates, rising markets and relatively low volatility.
Macro drivers
On top of its relative appeal versus equities, they believe infrastructure should benefit from several macro drivers in 2023 and beyond. First, energy security is driving policy globally right now, and a significant amount of infrastructure will need to be built to attain energy security. High gas prices and supply constraints brought on by the Russia/Ukraine war highlighted the importance of energy security and energy investment, Cresbridge said. This is supportive of energy infrastructure, particularly in Europe, where additional capacity is needed to supplant Russian oil and gas supply, and in the United States, where new basins are starting up, in part to meet fresh demand from Europe.
In transport, changing trade routes and adjustments to supply chains to bring production closer to home, either through reshoring or near-shoring, are driving demand for new transport infrastructure. Airports are still struggling to return to pre-pandemic passenger levels, and which will likely be interrupted by a global recession in 2023.
In addition, the industry is facing changes in long-term trends like business travel. Communications infrastructure continues to roll out 5G, develop 6G technology, and is working to reduce network latency, driving significant investments in wireless tower businesses, generally undertaken under long-term inflation-linked contracts. However, in the short term, higher interest costs are hitting the bottom line, the firm’s investment figures said.
In terms of fiscal policy, the US Inflation Reduction Act, signed into law by President Joe Biden in August 2022, is one of the most significant pieces of climate legislation in US history. They believe it will be industry-transformative for utilities and renewables in particular.
The growing need for electrification – including more electric vehicles charging infrastructure and more residential and smaller commercial rooftop solar—will require new substations, new transformers and upgraded wires along distribution networks. They already see its impact in the 2023 capital expenditures plans of utilities, together with the forward order books of companies involved in the energy transition—such as renewable, storage and components suppliers – increasing their growth profiles.
One major macro takeaway from the US legislation is that there is no reason to build anything other than renewables from now on, Cresbridge said. The main reason? Tax credits. Production tax credits for solar/wind are available until 2032 or until a 75 per cent reduction in greenhouse gases is achieved. Either way, this is expected to be a tailwind for investment for well over a decade.
Secular growth drivers for infrastructure should be on full display in 2023. President Biden wants to reduce emissions by 50 per cent in the US by 2030, with roughly half of US power coming from solar plants by 2050. It will require nearly $320 billion to be invested in electricity transmission infrastructure by 2030 to meet net zero by 2050. The dire need for infrastructure spending underpins growth for the next decade and beyond, and the first steps for meeting these long-term goals are being taken now, they said.