Thoughts on the Current State of the Market
Our Approach With Respect to the Overall Market
The stock markets enjoyed very strong gains from 2019 through 2021, overcoming a horrible pandemic. Valuations got very high for good companies; lots of inexperienced investors got involved with “meme” stocks; and bubbles formed in faddish asset classes like SPACs and cryptocurrencies. When this kind of environment takes over, it should be no surprise when the market eventually takes a break and retraces. Corrections and bear markets are supposed to happen. The S&P 500 is down almost 20% now and tech stocks are down much more. Looking back at the exuberant period we just came out of, the drawdown of early 2022 appears to be an appropriate release on the pressure valve. However, market trends rarely stop at “appropriate” or “rational” – this downward swing could easily continue and inflict a lot more short-term pain. It is not a prediction, but we need to be prepared.
Our investment strategy has built-in preparation because we only invest in solid companies with great long-term prospects and balance sheets strong enough to withstand significant economic downturns. The odds of any of our major stockholdings taking permanent losses or going to zero, due to business problems and/or too much debt, are remote. Unfortunately, that does not mean these companies are insulated from the market selloff. Low turnover strategies like ours require us to avoid panicking and selling when volatility hits. We do not have trading tactics or tricks up our sleeve to completely shield ourselves from drawdowns. Our short positions do help, but we are long-biased so our portfolio does not ‘zig’ when the market ‘zags’.
Other than the solid companies we are invested in, our source of strength is the cash we maintain. The point of building and maintaining a significant cash balance when times are good is to a) cushion against overall market downturns and b) deploy the cash when our existing positions and target stocks drop to levels where the risk/reward balance is too good to pass up. We are starting to see some widening gaps between our valuations and the stock prices, but overall we would not say right now that bargains are to be found everywhere in Cleantech. That mainly speaks to how high valuations had gotten last year; we have to look past the headlines of a given stock dropping by 50% or more because that does not necessarily mean it is cheap now! If this drawdown gets worse though, we will be intensely focused on acting on the best opportunities.
When pessimism is this excessive, any incrementally good news could generate a mini-rally in the markets. Examples might be news of supply chains debottlenecking at the Port of Long Beach / Los Angeles, China lifting COVID lockdowns, or an indication of a light at the end of the tunnel to the war in Ukraine. Some of the biggest daily up-moves in markets happen during volatile retrenchment periods like we are going through now[1]. If we try to get too cute with portfolio exposure or market timing during these downdrafts, we risk missing the big up-days which can cause a real drag on long-term performance.
Our long-term investment strategy definitely calls for patience during times like these. We thank you for believing in the approach and sticking with us!
Discussion Specific to Cleantech
Media following the cleantech industry in the U.S. are fixated on the trade complaint from a small solar manufacturer that could cause the federal government to impose tariffs on imports of solar components. This would disrupt the downstream industries (i.e., solar project development and installation) in the U.S. The predictions offered such as in the article linked above are certainly gloomy, but also to be expected given that they come from the solar industry association which naturally is interested in going public with the worst-case narrative.
This is a case where history is almost perfectly rhyming with 10 years ago, when a group led by a similarly insignificant domestic manufacturer initiated a trade complaint against Chinese solar cell and module imports. Eventually the U.S. did indeed place tariffs on Chinese cells and modules, which shifted a lot of production to southeast Asia. Fast forward to today, the current trade complaint is an attempt to play the whack-a-mole game by limiting imports from the new production centers in southeast Asia.
The solar market thrived in the U.S. during the last decade despite these issues. It is difficult to imagine the federal government completely kneecapping solar developers and installers when the reality is that, for better or worse, the downstream solar business is so much bigger than manufacturing in the U.S. Also, there are many announced national and state-level goals around reducing carbon emissions, and the Biden Administration has been wanting to add more meaningful support to Cleantech industries via the Build Back Better Act. It would be bewildering if the government provided incentives on one hand to build out renewable energy, and simultaneously made it more expensive to do so via import tariffs.
Of course we can’t put it past the government to do something bewildering or counterproductive. Just the threat of tariffs causes damage now because installers stop procuring equipment for fear of retroactively applied tariffs.
If restrictive tariffs are imposed, the global industry will adapt like it did during the last decade. For example, Mexico is a promising place to build cheap equipment (as SolarEdge and others are doing for inverters) and makes more sense for U.S. imports anyway since it is right next door. Furthermore, shortening supply chains had already come to top of mind before this trade complaint due to the broader upheavals caused by the pandemic. So adaptions are already underway, but they will take time. From an investor’s perspective, it is important to be exposed to companies with strong balance sheets and are globally diversified so they can withstand major business challenges in at least one major market.
1 https://advisor.mp.morningstar.com/resourceDownload?type=publicForms&id=3f9dff3c-f085-47a1-98ba-0bc008df9f25. See slide 15.