What does the historic US Inflation Reduction Act mean for global investors?

The US Inflation Reduction Act (IRA), will have both climate and multi-asset implications. Franklin Templeton Investment Solutions examines the IRA from an investment lens.

US President Joe Biden inked the Inflation Reduction Act (IRA) into law on August 16. Contrary to the bill’s name, we expect minimal impact on near-term inflation, which we see as peaking soon but slower to normalise. We see this bill as a colossal step for the United States in the battle against climate change.

Investment Opportunities

This legislation will likely be transformative over the long term as it is the largest government-led investment in clean energy in US history. Overall, there will be US$369 billion spending allocated toward climate and energy programs, with significant investment implications.²

The US goal is to achieve a 50%-52% reduction in greenhouse gas emissions (from 2005 levels) by 2030. The disparity between our current emissions and the end-goal is significant, but the latest forecasts show the IRA could help close this gap by nearly two thirds, cutting annual emissions by an additional one billion metric tons.^3,4

This legislation incentivizes the transition to renewable energy with longer-lasting tax and manufacturing credits that could change how companies and consumers make capital allocation decisions. In general, we see the following as likely winners:

• Utilities that have sizeable leads in alternative power generation will extend leads, and those with negligible exposure will be incentivized to enter.
• Fossil fuel companies with a credible transition plan to renewables. Examples include those far along in business lines like air carbon capture and storage or capturing carbon from high intensity areas like chemicals, cement and steel production.
• New companies that are creating novel technologies to assist in carbon capture, and venture-backed companies in industries like wind and solar equipment, battery systems and storage and rare-earth materials.
• A gradual shift in consumer behaviour toward electric vehicles and solar panels could accelerate consumption over time.
• We see positive implications for multi-industry companies that sell into the grid, infrastructure, and electric battery markets.

We recognize the cost of the energy transition is high, but the goal of the new law is to influence the market to adopt renewables. It should hasten the day when new clean tech costs match, then fall below, traditional methods.  

Multi-asset perspective

Taking a step back and looking at the IRA as a whole, we think this is a positive for US economic growth and equity valuations. Valuation implications are challenging to pinpoint, but we believe this could lower risk over a 10–15-year horizon as risks like physical climate damage diminish. There are modest earnings-per-share offsets; the legislation includes a corporate minimum tax of 15% for companies with income over US$1 billion per year and a 1% excise tax on share buybacks. This could incentivize higher dividend payments and/or capital expenditures (which are used to maintain or grow a business).

At a higher level, we utilize a growth, inflation, rates, and valuation framework when determining asset allocations, and specifically, we see a modest boost to growth through increased spending on clean energy, higher job formation and increased capital spending with longer lived incentives. We expect slightly higher equity valuations in the industries previously highlighted as “winners,” from higher growth and a lower weighted average cost of capital.

Fixed Income markets should see increased issuance in the many types of environmental, social and governance (ESG)-related bonds, including green bonds, social bonds, sustainability bonds, sustainability-linked bonds, transition bonds, SDG-linked bonds and maybe even blue bonds. We think inflation is peaking now but will remain elevated until the second half of 2023.

In the meantime, we see a Federal Reserve (Fed) committed to a course of monetary tightening to bring inflation under control. As Fed Chair Powell stated, “The successful Volcker disinflation in the early 1980s followed multiple failed attempts to lower inflation over the previous 15 years. A lengthy period of very restrictive monetary policy was ultimately needed…”⁵ The markets are hungry for a policy pivot, but we remain patient. We’re watching second-derivative inflation indicators like supply chain bottlenecks and demand destruction closely.

The rise and fall of COVID-19 leaves the world an unprecedented, increasingly complex place. Back to the IRA, we have conviction that it will be positive for long-term growth and offers potential to lower risk premiums over time.

Building Diversified Portfolios – Understanding Asset Classes  

At Partnervest, we create portfolios that span asset classes based on a careful analysis of the underlying exposures within. These portfolios are then adjusted to consider the relative attractiveness of different each asset class given the prevailing economic conditions, whilst maintaining targeted risk and return parameters. 

Our online platform is designed to make it easy for you to allocate your cash to a portfolio of carefully selected investment products designed to harness the benefits of diversification, and specified to target risk and volatility levels. In a world of rising uncertainty and fast-moving markets, having a partner that can help you invest your wealth quickly, easily, and intelligently can make all the difference.

To learn more about how you can start building a sound financial future, visit our website or contact Serg Premier, Managing Director on 0425 746 711.

Authors: Gene Podkaminer, CFA, Kimberly Strand, CFA, Julia Quinlan, Franklin Templeton Investment Solutions.

Endnotes

1. Source: C. Hickman, E. Marks, et. al. (2021). Climate anxiety in children and young people and their beliefs about government responses to climate change: a global survey. The Lancet Planetary Health 5(12), E863-E873.
2. Source: US Department of Energy. Office of Policy. The Inflation Reduction Act Drives Significant Emissions Reductions and Positions America to Reach Our Climate Goals, August 2022.
3. Source: Jenkins, J.D., Mayfield, E.N., Farbes, J., Jones, R., Patankar, N., Xu, Q., Schivley, G., “Preliminary Report: The Climate and Energy Impacts of the Inflation Reduction Act of 2022,” REPEAT Project, Princeton, NJ, August 2022.
4. Source: US Department of Energy. Office of Policy. The Inflation Reduction Act Drives Significant Emissions Reductions and Positions America to Reach Our Climate Goals, August 2022.
5. Source: “Reassessing Constraints on the Economy and Policy.” Symposium sponsored by Federal Reserve Bank of Kansas City. Jackson Hole, Wyoming. August 26, 2022.

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The information in this presentation is of a general nature only and is not intended to be, and is not, a complete or definitive statement of the matters described in it. The information does not constitute specific investment advice and does not include recommendations on any particular securities. Franklin Templeton Australia Limited nor any of its related parties, guarantee the repayment of capital or performance of any of the Franklin Templeton trusts referred to in this document. Although statements of fact in this presentation have been obtained from and are based upon sources Franklin Templeton Australia Limited believe to be reliable, we do not guarantee their accuracy, and any such information may be incomplete or condensed. All opinions and estimates included in this communication constitute our judgement as of the date of this communication and are subject to change without notice.

The unabridged version of this article was originally published in on the Franklin Templeton Australia website – Partnervest is a division of Franklin Templeton Australia Limited (ABN 76 004 835 849, AFSL 240827