T8 Energy Vision – Market update
Insights — October 2023
We share our latest observations on global asset markets regarding T8 Energy Vision
After strong positive returns during June and July, world equity markets experienced a second consecutive month of selling during September. Investors were in a ‘risk off’ mood across all geographies, with world equities falling by 4.3% (in US dollars), the worst monthly return of 2023. The United States and Europe (excluding the United Kingdom) were the worst performing regions (-4.8% and -4.9% in US dollars, respectively) while markets in the Asia Pacific retreated less (-2.7% in US dollars).
Investor uncertainty on the future path for interest rates (after an aggressive 18-month tightening cycle), appears to have been a significant catalyst for this drawdown. Resilient economic data out of the United States and persistent inflation was seen as reducing the likelihood of easing monetary policy (rates cuts) for the foreseeable future and increases the possibility of further interest rate hikes. Further, there was investor concern regarding how long tight monetary policy might remain in place and the long-term impact on the economy.
In response to this, investors continued reducing their allocation to long-dated US Treasury bonds in September causing a historically significant bond market sell off which saw 10-year and +20-year yields spiking by 46bps and 51bps, respectively (a 2 standard deviation move).
The correlation between equities and bonds remained elevated (above 90th percentile), which is another indicator of market stress, as both asset classes posted negative returns for the month.
In currency markets, investors looked for the safety of the US dollar which strengthened by 2.5% (trade-weighted basis).
The Clean Energy Index (generally comprising high-growth, small and mid-caps) followed the equity market lower, falling by 11.3%, as small and mid-cap companies (-5.7%) fell more than large caps (-4.9%) and growth stocks (-5.5%) underperformed value companies by 1.5% in September.
The utilities sector, which features heavily in the clean energy universe and is typically considered a safe haven (associated with its low volatility and long duration nature of its asset base), retreated by another 5.8% during the month due to its high sensitivity to rising bond yields. The utilities sector has been the biggest casualty in the bond route and is the worst performing equity market sector on a year-to-date basis (-16.5%).
Solar stocks (which are the largest allocation in T8 Energy Vision) finished a third consecutive month in negative territory (-9.0%) while companies focused on the wind sector fell by 14.5%. Both industries are part of the supply chain of (and in some cases are an alternative to) electric utilities. We believe this relationship to utilities and inferred sensitivity to rising bond yields combined with the characteristics of earlier stage companies (especially higher volatility) led to these stocks becoming a leveraged way to short the bond market.
In our view, shorting has been a key driver of the recent negative performance. Short interest in solar stocks peaked at an incredible 22% of shares outstanding or 14 days to cover (relative to its 5-year average of 2.3 days) compared to the Russell 1000 Growth Index at which peaked at 1.5 days to cover (relative to a 1.4 day 5-year average) which demonstrates the extraordinary pressure which the sector has faced from shorting.
The energy transition remains a priority for governments, corporates and consumers. We strongly believe that the present headwinds represent temporary factors which are related to the present macroeconomic environment. Clean energy’s performance relative to conventional energy companies (oil and gas producers +11.2% year-to-date) emphasises this notwithstanding the obvious structural headwinds for oil and gas in contrast with the obvious structural tailwinds for clean energy.
We are using the weakness to increase exposure to the highest quality names (companies with industry leadership positions, strong fundamentals, strong balance sheets and sustainable competitive advantage) which have experienced the most severe headwinds.