Climate scenarios and equity returns
In Short
This publication focuses on the impact of climate change on the equity market. Stocks are very long-term assets - in principle perpetual - and will be particularly exposed to the evolution of the impact of climate on economic activity.
Highlights:
- This report assesses the impact of standard climate scenarios on total returns of EU and US equity indexes over the medium to longer term.
- The scenarios considered are baseline, net zero, delayed transition, no further action. The last two are the most likely, based on firm commitments (as measured by MSCI “Implied Temperature Rise”) and recent literature.
- We use the scenarios based on a tool provided by Oxford Economics as the reference point and compare results with alternative approaches, incl. proprietary regression models, the National Institute General Economic model, a proprietary CAPE model, as well as one bottom-up alternative by MSCI model.
- All the approaches contain estimates of transition risk, i.e., how the reduction of greenhouse gas (GHG) affects profits and valuations. The impact of physical risk - very limited for the next few years - but highly relevant in the long run, is fully or partially included in the models.
- The models may differ in their underlying assumptions about the speed and intensity of the adjustment, as well as the decarbonization process and the ability to deliver technological improvements. Differences can be found in the response of policy makers to the climate issue and in the model specifications.
- High transition costs in the near term have a visible impact on equity returns over the next 5Y in the “net zero” scenario. In EMU our reference model, OE, shows a difference in equity TR of -0.8% per annum relative to the baseline. The average of the alternative models is -1.2%. In the US, the delta is higher, both for OE (-2.3%) and for the alternative models (-1.5%). Taking the average of these estimates would give a cumulative loss compared to the baseline of 5% in EMU and 9% in the US over five years.
- Over a 15Y horizon, the delayed transition scenario is the one in which equity returns suffer the most: we could get a cumulative loss versus the baseline of 17% in EMU and 13% in the US.
- In the longer term (2050), the no further action scenario shows strong adverse effects on equity returns as fallout of increased physical risks dominates. On the contrary, the outcome of the net-zero scenario would be the best.
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