After a strong rebound in July, markets fell in August, thanks to remarks from the Fed and renewed concerns about the path of interest rates. For the month, the S&P 500 fell 4.2%, the Dow fell 4.1%, and the NASDAQ fell 4.6%. That moves these major indices down to -17%, -13.2% and -25%, respectively, for the year.
But here’s the thing: Much like last month, the data continues to be mixed. The Fed seems to be taking a more hawkish approach and stronger stance on fighting inflation, but food prices fell 8.6% in July compared to the previous month, and gas prices were below $4 for the first time since March. Q2 earnings season is mostly done now, and surprisingly, 75% of S&P 500 companies reported positive earnings. At the same time, the housing market is softening, and the labor market remains extremely tight (strong demand for labor adds to future inflation expectations).
Economic numbers aren’t the only place we’re seeing mixed data. The regulatory environment shifted in August, as well, creating uncertainty in the impact investing sphere. On one hand, the Biden administration passed the Inflation Reduction Act (IRA), a landmark climate, tax, and spending act widely viewed as a big win. On the other hand, however, states like Florida are doubling down, making it illegal to use ESG screening criteria to select investments for state pensions. Texas is flat-out blacklisting financial institutions that lawmakers see as boycotting the fossil-fuel industry.
All this might create a rather confusing outlook for impact investors. While we love all the good that ESG and other kinds of impact investing can do, let’s not forget the financial benefits that come with this type of investing — especially in high-inflationary environments like the one we find ourselves in now. Let’s look at a few key areas within impact investing to see how their performance in the current environment is strengthening an already solid case for investment.
We’ll start with one of the main drivers of prolonged inflation this year: high energy prices. This runaway growth began as a result of the pandemic, but prices were further ignited by the war in Ukraine earlier this year. Higher prices for traditional energy create a strong incentive for governments, corporations, and individuals to go green.
Case in point: this August, when the Biden administration passed the Inflation Reduction Act. While not perfect, the act invests a whopping $369 billion into clean energy; it also has the potential to spur investment in this area to record heights. One of the main ways the bill provides incentive is by extending tax credits for these types of investments for up to 10 years. Having that kind of assurance allows local governments and businesses the regulatory certainty they need to make plans and invest in long-term projects.
Between higher costs for fossil fuels and tax incentives for going green, all of this should unlock even more investment opportunities in the still-early days of this country's energy transition.
Pandemic-related inflation has also impacted real estate in the US. Initially, lower supply from pandemic shutdowns and low mortgage rates at the start of the pandemic caused home prices to soar. But now, higher mortgage rates combined with still-higher home prices have made affordability in this country a real issue. Mortgage payments are close to 50% higher this year compared to 2021. To say nothing of the current housing supply shortage in the US — 3.8 million units, to be exact. All of this creates a strong environment for investment … and opportunity.
Historically, affordable housing — any type of housing that comes with some form of rent control — has been seen as a riskier segment of real estate, but recently that narrative has shifted. The typical cap rate (ie, the required rate of return used to compare properties) used to be 1% higher than other conventional housing, to compensate for that perceived higher risk. Now, that cap rate has shrunk all the way down to 0.25%, as investors have seen low-occupancy rates, more consistent rent collections, and steady income, even through the pandemic.
Higher inflation has also led banks to raise their interest rates and start tightening their lending standards. In Q2 of this year, one in four banks reported tightening their loan terms, and that number could continue growing. These shifts tend to make it tougher for small businesses — especially those started by people of color and white women — to access much-needed capital.
The solution: private lending and impact investing. The economy still offers a strong foundation, thanks to low unemployment, strong consumer spending, and solid corporate earnings (see mixed economic data above). So as an investor in this type of environment, why not lend to small businesses? Well, private lending comes with risk (like all investments), and in this case credit and liquidity risks are at the forefront. However, after considering these risks (and your goals), this can be a great way to have a meaningful impact while also earning solid returns. Some strategies even tie loans to revenues, which have the potential to grow over time with inflation. (Btw, if you focus on lending to women-led small businesses, you can rest easy knowing women repay loans at higher rates than men, not to mention tend to post better financial results as entrepreneurs.)
What can I do?
No one likes inflation — especially really high inflation, like the kind we’re weathering now. It’s a burden on economic stability and financial markets. But it doesn’t have to be bad for your investments. If you’re an impact investor, it can even be beneficial. Bottom line: There’s still plenty of opportunity to both make a difference AND earn financial returns … even in this kind of environment.
To learn more, click here to contact a financial advisor in your area.
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