Alternative energy stocks have performed so poorly this year that the PowerShares WilderHill Clean Energy (ETF) (NYSEARCA:PBW) and the Guggenheim Solar ETF (NYSEARCA:TAN) are down 20% and 34% this year, respectively. To make matters even more frustrating for alternative energy investors, the Market Vectors-Coal ETF (NYSEARCA:KOL) has more than doubled this year.
If you are invested in alternative energy stocks and have watched your investment plummet this year while coal stocks have dominated the market, don’t feel bad. This may have been a costly mistake. Luckily, there are very important lessons to learn.
The good news is, there is nothing wrong with your idea that alternative energy stocks represent the future. But being right doesn’t necessarily mean making money. Believe it or not, the problem may be that too many other investors agree with your idea.
Billionaire investor Howard Marks calls this type of thinking “first-level thinking.”
First-level thinking is the idea that a company is a good company or an industry is a good industry; therefore, buying a related stock or ETF is a good investment. Marks reminds investors that smart investing isn’t easy. “Anyone who finds it easy is stupid,” he once said.
If an idea, such as alternative energy stocks, electric cars, marijuana legalization or commercial space flight seems like a no-brainer, the first-level idea may not work as well as you think it will.
Jumping the Gun on Alternative Energy Stocks
One major reason that alternative energy stocks have lagged significantly in the past year is because investors got ahead of themselves. Yes, alternative energy is the future, but the future might not be here for a while.
In its 2016 annual global energy report, the U.S. Energy Information Administration projected that U.S. reliance on alternative energy will rise significantly by 2040. However, the EIA also projects that in the year 2040, fossil fuels will still account for a 77% of total U.S. primary energy consumption.
Yes, the world will likely eventually wean itself off of fossil fuels and convert entirely to alternative energy sources. The transition is happening, but it likely won’t be completed in my lifetime.
Coal Stocks Could Keep Beating Alternative Energy Stocks
Don’t invest in an alternative energy ETF like TAN or PBW based solely on the idea that alternative energy stocks are “the future.” Coal is not the future, yet KOL and coal stocks are up huge this year. After watching coal’s outperformance, it’s easy to throw up your hands and say the stock market is rigged. But figuring out the real reasons behind the move requires second-level thinking.
First of all, KOL was down 57% in 2015, so coal stocks were relatively cheap at the beginning of the year. Second, there has been a wave of U.S. coal bankruptcies. Ironically, the companies that survived now get a bigger piece of the pie. Finally, China is by far the largest global coal producer. China unleashed a string of new regulations this year limiting the number of days coal miners can operate. China also placed new restrictions on land transport. Less U.S. supply, plus less Chinese supply, plus persistent demand equals higher coal prices. Higher prices mean more profits for coal stocks.
Sure, solar energy is the future. But before you invest, you need to understand how energy prices, competition, government subsidies, the debt market and investor sentiment affect alternative energy stocks. If not, you’re in danger of falling victim to first-level investing.
As of this writing, Wayne Duggan did not hold a position in any of the aforementioned securities.