Infrastructure Is a Patient Trade

Summary

• Clean energy and electric vehicle ETFs took a big hit in February and March when rising rates sparked a rotation out of growth and into value stocks.
• We expect these sectors will return to the pre-election trend, although the road forward will likely be bumpy.
• Challenges include turning President Biden’s infrastructure proposal into legislation and scaling renewable energy rapidly enough to meet emission goals given natural resource and technology constraints.

Market Implications

• Clean energy and electric vehicle technologies are clearly the wave of the future. We see ETFs in these sectors primarily as buy-and-hold investments currently, although volatility is possible.
• ETFs in traditional infrastructure should outperform the S&P 500 as infrastructure spending starts to flow, but they lack the growth potential of the clean energy or electric vehicle sectors.

In mid-February, we previewed President Joe Biden’s anticipated infrastructure plan and likely market impact. We opined that the clean energy and electric vehicles sectors seemed priced for perfection even if the plan delivered big for them. The plan was released on 31 March, and it did indeed deliver big.

But clean energy and electric vehicle ETFs had already taken a big hit beginning around when we published our note (Chart 1), falling 22.7% and 12.5% by 8 March. Since then, they have traded in a narrow range even after the infrastructure plan’s release. Traditional infrastructure (e.g., utilities, construction companies, and pipelines) have traded in line with the S&P 500.^[1]

Rising Rates and Oil Spark Re-rating

There were various reasons for the selloff. More generally, rising rates set off a rotation out of growth stocks to value stocks and sparked concerns about the impact of higher-cost debt in the future for capital-intensive companies.

More specifically, the energy sector ETF XLE jumped 25% on rising oil prices as investors focused on better near-term prospects for fossil energy companies. Ongoing focus on the forthcoming infrastructure plan may also have led more people to consider other issues. These include increased competition from new entrants and established fossil energy companies as well as the daunting technical challenges of making renewable energy more widespread.

In any case, the net result of the selloff was to return clean energy and electric vehicle ETFs to roughly the trendline they were on between April 2020 and the election – or in effect prick a mini-bubble.

Emerging Technologies Will Keep Battling Headwinds

We don’t expect another significant selloff in clean energy or electric vehicle ETFs relative to the broader market although there is one big risk in coming months. In the interests of getting something passed, some or much of the clean energy/electric vehicle portions of the infrastructure plan could get dropped as they progress through the congressional sausage-making legislative process. But it may be several months before we can see whether that scenario is a possibility.

It is also unlikely that clean energy and electric vehicles ETFs mount another rally like during the post-election period anytime soon (unless some breakthrough new technology bursts onto the scene). Apart from legislative uncertainty, developing renewable energy technology and electric car batteries on the scale needed to significantly reduce carbon emissions in coming decades will require huge volumes of natural resources such as copper, nickel, lithium and cobalt.

It is currently unclear whether forthcoming supply will be sufficient to match this scale. It is also unlikely that current technology such as lithium batteries will be robust enough to meet future needs, and at this point, alternative technologies are still in the early stage of development.

Buy-and-Hold Time

Ultimately, clean energy and non-fossil fuel vehicles are the wave of the future. But the path forward is hardly the gleaming yellow brick road of The Wizard of Oz. We can see the clean energy and electric vehicle sectors experiencing further manic and depressive cycles, although we are reasonably certain the next manic stage is some time off even if Biden’s infrastructure plan is enacted.

Investors who can live with some volatility should hold these ETFs as a buy-and-hold investment.

We anticipate traditional infrastructure ETFs should outperform the S&P 500 as infrastructure spending starts to flow, although they lack the same upside as clean energy or electric vehicles.

How We Create ETF Indices

We group about 28 infrastructure-related ETFs into three subgroups (Table 1) and calculate daily price returns for each one. We then calculate average daily returns and cumulative returns for each group.

1. The purple and green portions of the clean energy and electric vehicle sectors, respectively, cover the period between April 2020 and the election. ↑