Over the long term, randomness is smoothed out, and fundamentals often dictate a company's value. But in the short term, anything can happen in the stock market. And a big part of stock price movements can be based on external factors, such as interest rates and Fed policy, emotions like fear and greed, and which themes are in or out of favor.
In 2023, artificial intelligence (AI), which is not a new concept by any means, made a huge comeback and caught investor enthusiasm. It's a trend that could continue generating rewards for a long time, especially because it opens the door to new growth opportunities for existing companies with a lot of cash to spend.
But I like one trend even more than AI in 2024: the energy transition. Here's why it has room to run, along with three exchange-traded funds (ETFs) worth considering.
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An interest rate story
Renewable energy stocks have come back nicely over the last month or so. But even so, the industry is still down big on the year despite a strong overall market. The key reason for the underperformance is interest rates.
Investing in renewable energy is capital intensive. For utility-scale solar and wind farms to achieve comparable efficiency to a combined-cycle natural gas power plant, they must be sizable and operated well.
These projects are a logistics and planning feat, to begin with. So, when the return on investment goes down because of higher rates, developers might prefer hitting the pause button and waiting for the dynamics to shift back in their favor.
Industrial companies investing in low-carbon fuels, like blending hydrogen with natural gas in industrial processes, are probably doing it for the environmental and economic benefits. In a period of high borrowing costs, the environmental benefits will look less attractive, and the focus will shift toward economics.
The same goes for the transportation industry. There's plenty of room for electric vehicles (EVs), hydrogen vehicles, biodiesel, and compressed natural gas to make impacts. But again, it's more difficult to justify investing in new projects when interest rates are high.
Rising interest rates also pressure consumers. Getting a new EV or being a first-time EV buyer is less appealing when borrowing costs are high. Investing in residential solar also seems expensive compared to when interest rates are lower.
In sum, the energy transition is a big-picture idea. And big-picture ideas can lose their luster when the cycle shifts to the downside.
Fortunately, nothing has changed about the long-term investment thesis. Companies are committing to environmental goals and taking environmental considerations into account. The oil and gas industry is pressured to lower emissions and transition toward cleaner forms of energy. Governments are supporting the energy transition with funding, with many countries making aggressive plans to cut near-term and long-term emissions.
The performance of the renewable energy industry in 2023 illustrates how quickly markets can abandon an idea and turn their attention toward a different opportunity, even if the theme has plenty of room to run over time.
With the worst of inflation likely in the rearview mirror and interest rates set to fall next year, energy transition investments could see a nice rebound in 2024 and beyond.
A pure-play solar ETF
The Invesco Solar ETF (TAN -1.28%) is down 27.9% year to date (YTD) -- and that's even when factoring in the ETF's more than 14% gain in the past month.
This fund is the best choice if you want to play the energy transition through the solar industry. Enphase Energy, First Solar, and SolarEdge Technologies round out the three largest holdings and make up nearly 30% of the fund.
But there are plenty of companies in the ETF you might never have heard of -- many of them being international parts and component suppliers or technology companies. There's also a fair share of utility companies, adding stability to an otherwise volatile mix of growth stocks.
Overall, the ETF is a great way to gain exposure to parts of the industry that would otherwise be difficult to invest in. One drawback is the ETF's hefty 0.69% expense ratio, but it's a fair price given it would be challenging to individually invest in many of the fund's international stocks.
An EV focus on the energy transition
The Clean Edge Green Energy Fund (QCLN -1.60%) has been on a tear recently. And a big reason for that is Rivian's outperformance (it's now the fund's largest holding at 9.1%) as well as an overall rebound across many of the fund's key themes, including EVs, solar, and more.
The Clean Edge Green Energy Fund's second-largest holding is ON Semiconductor, a chip company poised for growth with the EV market. The fourth largest holding is Tesla. Other holdings include companies indirectly investing in the EV industry, such as lithium miner Albemarle. So overall, this is an ETF that is playing the energy transition through the lens of the EV industry.
It has an expense ratio of 0.58%, which isn't cheap as far as ETFs go. But the fund has its benefits and could be a great fit if its themes align with your interests.
Investing in renewable energy production
The iShares Global Clean Energy ETF (ICLN -0.60%) is a good choice if you want to play the energy transition through a mix of domestic and international solar and wind companies. Unlike the two other ETFs, some of this fund's top holdings are major wind companies. Vestas is the third largest holding, and Orsted is the fifth largest. Both are Danish wind-energy developers.
Similar to the Invesco Solar ETF, Enphase and First Solar are the two top holdings, respectively. And as you go down the line of holdings, you'll see a lot of similarities between the two ETFs.
One of the bigger differences is that the Global Clean Energy ETF is more targeted toward energy producers than the Invesco Solar ETF, which focuses more on the solar supply chain. Both funds are worth investing in, but this one could be a better fit if you want to explore wind and solar.
The fund's 0.41% expense ratio is slightly lower than the other two ETFs. But it is still relatively high compared to other ETFs that are out there.
Start simple
ETFs are a good way to dip your toes into an industry while achieving instant diversification. Down the road, an individual company or two might pique your interest. In which case, it makes sense to invest in individual stocks that fit your interests and risk tolerance.
It could take time for the energy transition to regain excitement from Wall Street. But long-term investors know that the market does eventually catch up. And if fundamentals start improving sooner than expected, top renewable energy stocks could prove explosive.
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