The first quarter of 2018 was one of the more volatile quarters in recent performance history for Green Alpha strategies, as well as for global and U.S. equities in general. Let’s review the “whens” and “whats” of this shift, and how this relates to the ongoing tech revolution.
The beginning of the quarter saw a continuation of 2017’s bull run for stocks as investors were persuaded that the passage of the Republican tax plan, in lowering taxes for U.S. corporations, would make business more profitable and earnings increases would follow. However, sentiment shifted abruptly following the January employment figures, as investors were spooked by rising wages, in turn raising inflation and thus interest rate fears, meaning corporate earnings could be projected to decrease as they would have to pay more interest on their debt. But then, by the end of March, inflation fears were allayed somewhat as Chicago Purchasing Manager Index (PMI) fell in March to a reading of 57.4, which was a one-year low, from 61.9 in February. So perhaps inflation won’t be too severe, and interest rates may not need to rise as much after all.
Cue late March stock rally. All this keeps the Fed in its difficult position; it must normalize rates without hindering economic growth, while trying to predict overall price inflation in the face of sometimes conflicting data.
We’ve also seen a lot of volatility align with signals of on-again, off-again trade war threats. Experience (some very recent) shows that while tariffs are meant to shore up U.S. industry, retaliatory tariffs from countries importing U.S. exports make those exports less competitive. This leads to a counter effect, wherein domestic consumers see higher prices for products they buy, less demand for the products they make, lower pay, and higher unemployment. Here, as with climate science, we see the U.S. increasingly outside of the global mainstream. Formerly the champions and great beneficiaries of trade and globalization, the U.S. is now seen by many as running the other way, raising general economic uncertainty and raising market volatility.
We’ll keep watching. Short-term developments, while not particularly meaningful in terms of portfolio returns for the long-term investor, do add up over time into the long-term picture. Events at the beginning of a major transition can have large effects on how the economy evolves. For example, tariffs that aim to thwart the growth of renewable energies in the U.S. mean that the U.S. is willingly giving up its historical lead in the solar industry, particularly in solar PV. We are encouraged that the best efforts of incumbent fossil fuel interests in the U.S. have not managed to stop growth in renewables – a sign that renewables’ advantageous economics are hard to repudiate – but we can simultaneously lament that the momentum and growth in these key technologies is now being ceded to markets more enthusiastic about developing them (read: China).
As always, our response to all this is to keep our focus on the long-term, remaining invested in multi-year growth trends that will ultimately be affected less by shorter term policy machinations and more by innovative pursuit. This also underscores the importance of looking for Next Economy opportunities across the globe. If combative, protectionist economics hampers the U.S.’s efficiency-led growth, other nations will continue to pick up the slack, and we as investors will seek those global opportunities accordingly.
When thinking about the larger story of the Next Economy, we know that there will always be inevitable moments of setback and slowdown amidst prevailing long-term growth and evolution. And Q1 did indeed see much more important, long-term indications of development across several areas of the Next Economy. Even in the presence of political noise, the energy space has been successfully pulling away from the inefficient legacy economy. Wind power firms announced development of turbines over 250 meters in length generating 12 megawatts, capable of powering 16,000 households at a time, making it likely that the price of wind generated electricity will continue to fall.
And we’ve already seen some significant price declines. Bloomberg reported that “The economic case for building new coal and gas capacity is crumbling, as batteries start to encroach on the flexibility and peaking revenues enjoyed by fossil fuel plants.” The three key technologies driving this shift experienced impressive price declines between 2010-2017; total costs fell by 77% for solar PV, 38% for onshore wind, and 79% for lithium-ion battery storage. When we see such phenomenal price declines over the course of seven short years, achieving economic sustainability looks like more than a dream.
Solar may particularly benefit from significantly larger scale, and Q1 saw no shortage of evidence that global installations continue to boom. We learned that global solar capacity grew faster than fossil fuels in 2017, and China installed an unprecedented 97 gigawatts (GW) of solar capacity in the year. We also heard that Soft Bank and Saudi Arabia will be collaborating on the world’s largest solar power generation project, expected to ultimately have the capacity to produce up to 200GW.
Meanwhile, in the automotive sector, U.S. EV sales in March 2018 grew 42% versus March 2017. This is a lot considering that the U.S. is a laggard in global terms; at least a dozen nations, including the world’s largest auto market, China, have indicated an intention to ban internal combustion engine vehicles altogether in the coming couple of decades. What about EVs deployed for businesses? Consider this headline: “‘It’s the beginning of the end’ for internal combustion engines, says UPS as it updates its fleet to electric.”
The electric transportation revolution is now visible even in aviation. In Q1, we saw electric aircraft start to take shape in reality as multiple designers showed off practical designs and prototypes, and Norway announced it will make all short-haul flights electric by 2040.
The strands are coming together, almost faster than we can keep up with them, to form a clear story of global economic evolution that is significant, enduring, and likely to be profitable for early adopters. The short-term Q1 ephemera will be only memories before long, while the tsunami of the global transition to the Next Economy will continue to prove unstoppable. Here’s to an exciting Q2.
When reading the portfolio-specific comments below, we recommend opening our Quarterly Portfolio Review documents. You can find links to them at the beginning of each brief portfolio commentary section below. On page five of each portfolio’s document, you’ll find full since inception performance details and a sector attribution chart that can provide visuals to aid the descriptions below.
Next Economy Index
We were pleased to see the Next Economy Index deliver a modestly positive return in a very tumultuous first quarter of 2018. The lion’s share of the positive return was from the sector with the largest allocation in the Index—technology. Within tech, there was an advanced semiconductor rally, and we also saw solid gains from software and digital security. Energy and communications tied for second largest contributing sectors. Solar and wind equipment makers and installers did particularly well, while utilities and manufacturers lagged this quarter. Our second largest sector by allocation, industrials, was responsible for most of the negative performing names. This was partly due to concentration in the sector and because the lighting and display sub-sector of industrials fared particularly poorly in the quarter. Electric vehicles also detracted from performance, which led consumer cyclicals as a sector to be the second most detracting sector in the portfolio. Consumer cyclicals were also impacted by concerns about capital spending, which kept sustainable office furniture makers negative for the quarter. In the non-cyclical consumer sector, organic foods and the healthcare complex were the worst performers.
Sierra Club Green Alpha
The Sierra Club Green Alpha Portfolio saw overall negative performance for the quarter. Energy and technology sectors countered this trend, providing positive returns. As with the Next Economy Index, solar and wind equipment makers and installers did particularly well, while utilities and OEMs detracted from returns. In tech, semiconductors and Internet of Things technology fared well. On the negative side, the Sierra Club portfolio took losses in the electric vehicle sub-sector of consumer cyclicals, despite EVs gaining market share from traditional internal combustion engine vehicles during the period.
Growth & Income Portfolio
Despite being a relatively low volatility portfolio among Green Alpha strategies and its history as one our strongest performers, the Growth & Income Portfolio was our worst performing strategy for Q1, with an overall contribution of -4.96%. Technology and consumer non-cyclicals each provided modest positive returns, but these were not enough to overcome losses in REITS and other financials, which together with energy and utilities, were responsible for nearly half the overall loss in Q1. Another contributing factor may have been a rotation away from dividend-paying stocks in Q1, as interest rates rose modestly economy-wide. This provides investors with other opportunities to earn investment income apart from stock dividends, which for at least the past three years had been nearly the only place to seek yield. Dividend-yield is, of course, a key theme of the Growth & Income Portfolio, making such repositioning disadvantageous for the portfolio.
Next Economy Select
The Next Economy Select portfolio was negative for the quarter. The only sector with positive performance was technology, led by semiconductors, front-end capital equipment makers, and digital security. The worst performing sector was industrials, largely due to the lighting and display sub-sector of industrials performing particularly poorly in the quarter. Basic materials, including steel, detracted during Q1, in spite of policy efforts to bolster the industry. Consumer cyclicals also detracted from performance, mostly due to the poor performance among electric vehicle makers, despite EVs gaining market share from traditional internal combustion engine vehicles during the period.
Important Information and Disclosures
This commentary is for informational purposes only and should not be construed as legal, tax, investment or other advice. This commentary does not constitute an offer to sell or the solicitation of any offer to buy any security. Any discussion of an individual security is for illustrative purposes only and should not be considered a recommendation to buy or sell any security. The presentation does not purport to contain all of the information that may be required to evaluate Green Alpha Advisors and its investment strategies.
Sector performance information discussed represents past performance. Past performance does not guarantee future results and current performance may be lower or higher than the data quoted. Investment returns and principal will fluctuate with market and economic conditions and investors may have a gain or loss when shares are sold. For specific performance data for each Green Alpha portfolio, please refer to the performance and investment risk disclosures contained in the Quarterly Portfolio Reviews.
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