Are Clean Energy Stocks In Bubble Territory?

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By Alex Kimani

The Age of Renewable Energy is upon us, with the global shift to renewable energy in full swing, but like any huge rally, the divide between the bulls and the bears widens exponentially, with bears calling for another big bubble to burst, and the bulls standing their ground with no thoughts of conceding at all.  The bulls, of course, have a lot of ammunition.

Clean energy stocks have been hot throughout 2020 and are showing no signs of letting off steam in the new year, thanks to the rapidly changing political landscape in the United States.

The slim majority that the Democrats have clinched in the Senate is likely to help President-elect Joe Biden fulfill his pledge to promote clean energy and EVs through sweeping legislation such as the Green New Deal might be tougher to enact.

But that has not stopped investors from going out on a limb and bidding up clean energy securities to new highs.

The $5.5 billion (AUM) iShares Global Clean Energy ETF (ICLN), a catch-all bet on clean energy, has pulled in a record $691 million of inflows in the week after Democrats landed both of Georgia’s Senate seats while the $4.2 billion Invesco Solar ETF (TAN) is on track to add $370 million in just seven days—another all-time haul.

Meanwhile, the WilderHill Clean Energy Index (PBW) has already tucked on another 19% to start the year, following a 203% increase in 2020. All three funds are hovering around all-time highs.

And now, Wall Street is saying it might be best to pump the brakes as stock valuations in the renewable energy sector may be getting out of whack.

True, the early days of the clean energy boom were fed largely by wishful euphoria, as the Wall Street Journal points out, using the example of Tesla (NASDAQ:TSLA), which is now trading at more than 1,000 times trailing earnings.

But that “euphoria” has helped fund the next round of clean energy, which has more fundamental catalysts behind a rally. This is where it gets real.

Bubble in the Making?

In a note to clients, Raymond James analyst Pavel Molchanov, has downgraded five alternative energy and clean technology stocks urging investors to lock in profits and look for new opportunities.

Molchanov has downgraded Enphase Energy Inc. (NASDAQ:ENPH) to Underperform from Market Perform, labeling the maker of solar inverters as a “textbook example of overly euphoric sentiment.”

Molchanov notes that Enphase and close peer SolarEdge Technologies (NASDAQ:SEDG) remain the most dominant in module-level electronics for the U.S. residential market, “but new entrants are working to erode that duopoly.

The analyst says Enphase’s premium 50x EBITDA valuation leaves the company with little margin of error, meaning just about everything has to go right in the current year to justify the steep valuation.

Susquehanna’s alternative energy analyst Biju Perincheril has also downgraded both names to Neutral from Positive, citing stretched valuations. Perincheril has assigned new price targets of $195 for ENPH and $340 for SEDG, suggesting 6% and 5% downside, respectively.

Not everybody has bailed on Enphase, though, as Goldman Sachs has upgraded the stock while downgrading First Solar (NASDAQ: FSLR), citing a shifting preference toward residential solar and battery exposure.

Bad for ESG?

The biggest risk to the clean energy bull thesis is that these overly optimistic bets hinge on the slim majority that the Democrats hold on the Senate.

Additionally, it’s unclear how aggressively the Biden administration will pursue those policies considering the government’s top priority at the moment is to contain a pandemic that is rapidly spiraling out of control.

Perhaps even more interesting, a cross-section of Wall Street now sees the clean energy frenzy posing a major threat to other ESG stocks.

According to Bloomberg Intelligence analysts Eric Balchunas and Athanasios Psarofagis:

Clean-energy exchange-traded funds could bypass the broader ESG category in natural assets in the next few months if current trends hold. Flows into clean-energy ETFs have breadth and depth that typically portend a grassroots frenzy of buying as investors seek to grab exposure as fast as they can.”

Indeed, the 17.6% gain by the iShares ESG MSCI USA Leaders ETF (SUSL) in the past 52 weeks has only slightly outpaced the 16.9% rally by the S&P 500 and looks downright pedestrian compared to a 169% gain by ICLN and 260% by TAN.

And bubble fear isn’t confined to clean energy, either. A recent E*Trade Financial survey showed that most investors believe the stock market is in bubble territory. Some 66% of 904 investors managing at least $10,000 in an online brokerage account think the market is “either fully or somewhat in a bubble”, while 32% list a recession as their top portfolio risk at present. And it’s not just Tesla that’s on their minds …

Crude OIl

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