Solar Stocks Shine Again As Declining Treasury Yields Boost Market Confidence

Solar stocks have demonstrated some of the most robust performances among various sectors since the start of the month, buoyed by favorable market conditions and positive corporate earnings.

The Invesco Solar ETF TAN, which tracks the performance of approximately 40 solar energy companies, has experienced a significant upturn. Over the last 10 sessions, this ETF has surged by 10%, rebounding from its lowest point since July 2020. This rally is particularly noteworthy as it reflects broader investor optimism in the renewable energy sector.

Several factors have contributed to this positive momentum. A notable catalyst has been the decrease in long-dated U.S. Treasury yields, which have fallen substantially since late April.

Specifically, the 30-year Treasury yield dropped from a high of 4.85% to 4.63%, and the 10-year yield decreased from 4.73% to 4.50%. These declines in yields reduce the cost of borrowing and are especially beneficial for capital-intensive industries like solar energy.

The sensitivity between solar stock performance and Treasury yields is strong. Solar companies often rely on significant capital to fund their expansive projects. When Treasury yields rise, so do borrowing costs. Higher interest rates increase the cost of loans for solar firms, which can reduce their profitability and make their projects less economically viable.

Additionally, the value of solar stocks is frequently determined by the present value of their expected future cash flows. When Treasury yields increase, so does the discount rate used to calculate these cash flows. As a result, a rise in yields can lead to a decrease in the present value of these cash flows, negatively impacting stock prices.

This inverse relationship between solar stocks and Treasury yields is shown in the chart below

Chart: Solar Stocks Are Negatively Correlated With Long-Dated Treasury Yields

Industry Leader First Solar Signals A Turning Point

First Solar Inc. FSLR, a leader in the solar industry, recently reported first-quarter revenues of $794 million—well above the consensus estimate of $718 million. The company also exceeded earnings expectations, posting an adjusted EPS of $2.20 compared to the predicted $2.00.

Brian Lee, CFA, an equity analyst at Goldman Sachs, believes that “the pricing environment could be inflecting soon.” 

In particular, the analyst flags that “renewables demand from data centers represents a meaningful portion of FSLR’s demand mix” which could significantly influence the company’s order backlog in the near term.

Reflecting this optimism, Goldman Sachs has set a 12-month price target of $268 for First Solar, indicating a potential 38% increase from its current price levels.

Are Solar Stocks Expensive Or Cheap?

When considering the valuation of solar stocks, the Invesco Solar ETF is currently trading at 22 times its forward earnings. This multiple is significantly lower than the valuations seen during the 2020-2021 period when solar stocks were trading at up to 80 times their forward earnings. This indicates that solar stocks are relatively more affordable now compared to their peak valuations.

The future trajectory of the solar industry heavily relies on macroeconomic factors, particularly inflationary pressures and the Federal Reserve’s monetary policy.

A decrease in inflationary pressures, leading to lower Treasury yields on expectations of a policy shift by the Federal Reserve, could further brighten the outlook for the solar industry.

The likelihood of the Federal Reserve implementing rate cuts will play a crucial role in shaping the prospects for solar stocks in the coming months.

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