The stock market's green energy bubble will burst eventually, but it could help save the planet along the way

• There's a bubble forming in green energy stocks.
• While the bubble may eventually burst and hurt some investors, it could produce some good results along the way.
• By making it cheaper for companies to make green energy investments, the bubble could speed our shift away from carbon fuels and help to combat climate change.
• So the green energy stock bubble may burst, but it just might help save the planet along the way.
• George Pearkes is the global macro strategist for Bespoke Investment Group.
• This is an opinion column. The thoughts expressed are those of the author.
• Visit Business Insider's homepage for more stories.

Equity markets are trading with reckless abandon these days. Some of the greatest froth in this broader equity market bubble has come from stocks tied to renewable energy and decarbonization. This  begs the question: is a green energy bubble such a bad thing?

2020 was the hottest year on record according to the latest NASA numbers. Global temperatures are modeled to rise 3 to 4 degrees Celsius by the end of this century without a significant change in emissions, so there is enormous urgency to reduce carbon emissions. The most recent full assessment models large declines in crop yields, increases in drought and declines in fresh water access, increases in extreme weather events, and a litany of other costs for the global population.

Governments have so far only had a limited response. Tax credits, modest carbon taxes, and other policy solutions have in large part been tinkering as opposed to confronting the problems of spiraling carbon emissions head-on. International efforts like the Paris Agreement were still voluntary and defined a grim 1.5 to 2 degree increase in temperatures globally as a success.

Without a widespread and concrete dollar price on carbon, the private capitalist economy hasn't made much headway in finding solutions, lacking large-scale incentives. Solar and wind tax credits have definitely helped spur renewable power development, but this is also for the most part tinkering. Despite surging renewables output the biggest single driver of reduced US carbon emissions appears to have been a technological "accident" of cheap fracked natural gas which has put coal on a path to ruin.

The bubble makes access to capital extremely cheap

High valuations, aggressive interest from individual investors, and parabolic price action are all signs that the broad equity markets are in a bubble, but some of the most speculative equity market fervor is in renewables. 

Chinese electric carmaker Nio trades 62 times its revenue and is worth almost $100 billion. Electric truck company Nikola traded up to a market value of nearly $30 billion last summer with little concrete progress towards actually building its products. European wind energy giants Vestas and Siemens Gamesa trade around 100 times their earnings. 

Since mid-2018, MSCI's Global Alternative Energy Index has more than doubled. Its biggest members are offshore wind companies like Vestas, Orsted, Siemens Gamesa, and Northland Power, as well as solar stocks like Enhpase, SolarEdge, Xinyi, Sunrun, and First Solar.

That index now has a market cap almost one-third as large as the aggregate global Energy sector - a massive relative leap compared to 2019.

From the perspective of a corporate entity, stock market bubbles mean access to capital becomes extremely cheap. For existing companies, huge valuations make issuing lots of stock compelling to help fund years of expensive research and development or efforts to build out manufacturing capabilities. For new entrants, a hot SPAC or IPO market means easy access to capital without a proven business model.

A bubble with positive side effects

An equity market bubble that rewards companies focused on renewable energy will create similar situations: cheap capital that allows for long-term investment and makes ultimate commercial success more achievable. Shifting priorities from investors - if not governments - mean that huge flows are moving into "ESG" (environmental, social, and corporate governance) funds, which saw ETF inflows of almost $100 billion in inflows in 2020 alone.

Changes in investor behavior (both in terms of hunger for socially responsible investments and greed for the big parabolic moves) aren't the only factor helping stoke investor interest in green investments. 83 central banks are members of an international working group designed to "green" the financial system. The ECB has specifically sought to support green bond issuance. Nudges from monetary and regulatory policy are likely to further sweeten the appeal of decarbonization plays.

Of course, the current landscape of low interest rates also helps make multi-decade investments in nascent green energy solutions or large-scale infrastructure more attractive. Some of the largest investments in green energy are taking place as part of companies' existing plans for growth, and the giants of a green energy world will only grow faster with the lower rates which make long-term investments more attractive.

It's not going to be all roses, though: there will be casualties. Any asset bubble creates financial wreckage for later arrivals or investors who aren't able to cut their losses quickly enough. For ordinary people and institutional investors alike, it's critical to understand that even a permanent energy paradigm shift probably can't indefinitely support firms like hydrogen fuel cell company Plug Power, which trades at 70 times sales.

The opportunity offered by an equity market bubble in green stocks is not one for everyone to get rich, but to speed up the investment in research and development, infrastructure, and deployment of technologies that will allow a decarbonized future.

A similar process played out in the last tech bubble. Huge valuations and capital raises ultimately financed much of the internet infrastructure which allowed for "Web 2.0" innovation. Giants like Google, Facebook, Amazon, and Netflix are the result.

So long as investors and management teams don't apply much leverage (that is, borrowed money), the ripple effects of an equity market bubble are less likely to spiral across the economy as they did after the housing market crash. 

While there was a recession in the early-2000s, it wasn't a balance sheet recession like 2007-2009. There will still be many losers when financial reality is reasserted, but those who avoid direct exposure to the bubble in the form of purchasing lots of aggressively-valued stocks are less likely to be caught in the crossfire. 

With governments around the world so unwilling to make the hard decisions and big investments that fighting climate change requires, a green stock bubble at least offers a tailwind for cheaper decarbonization, a positive externality that may be critical in the effort to reduce the climate crisis that is already underway.