Certainly the past few weeks have tested all of us who watch the markets on a daily basis. The
month of August saw the Dow Jones Industrials down 6.57% and the S&P 500 down 5.26%, and
down 12.26% and 10.0% respectively from their recent highs through the first week of
September... not a “bear market” but certainly a correction in most investors’ books.
Though we were certainly overdue for a correction, we didn’t feel (and still don’t) that the U.S. economy was in danger of tipping back into a recession, so we were comfortable with most positions that we had.
“Riding the Energy Wave to the Future.” Our current views were crystalized recently by a newsletter by that title that I received from Dallas investor and economist John Mauldin, a writer who is comfortable with “unconventional” views… the kind of mind that helps us spot the trends that Wall Street hasn’t noticed yet.
To quote Mauldin:
"Events around the globe are combining to create huge economic change over the next few years. We are watching giant, multidimensional chess games played by some master players. Energy is the chessboard that connects all the players."
The market has been taking cues from oil prices in recent months, and if you have been taking
those cues the recent chaos begins to make some sense.
You see, every time the price of oil has taken another dive the stock markets have reacted with
a sympathetic dive. When the price of oil stabilized for a few days the markets rallied, with a
whiff of hope that the pain was over… then another parallel dive with the drop in oil prices.
At the risk of getting in the weeds here, the equity markets recognized (correctly) that lower oil
prices would cause severe spending cuts and layoffs in an industry that had been the beacon of
growth in our economy since 2010… not good for many companies (and likewise not good for
But the promise of much lower energy prices ($2.00 gasoline anyone?) should be felt like a tax
cut to most of us, right? Wouldn’t that be good for consumer products companies? That would
also be correct, but these benefits would take much longer to be felt by the consumers and
then even later by the companies which benefit from consumer spending… therefore not
benefitting the stock markets for a while.
One of the best contrary indicators ever discovered is called the “CoverPic Indicator.” Mauldin again reminds us about that indicator: "Contrarian and value investors like to buy assets that are in distress, or at least “out of favor.” You don’t hear much about those assets at the time. That’s part of being distressed – everyone ignores you. So, following that logic, the last thing you want to buy is a stock or industry that appears on the cover page of popular financial publications. Commodity and energy bulls should take note of last weekend’s Barron's cover."
"COMMODITIES: TIME TO BUY," Barron’s practically screamed.In case you can’t read the fine print on the cover, it says:
"The harsh selloff in energy, gold, and other commodities is starting to look like capitulation.
"Opportunities in Exxon, Chevron, BHP, Goldcorp. Plus six funds and six ETFs to help build a position in this oversold sector."
He goes on:
"I presume the photo is supposed to show the sun rising on an oil rig, not setting. The article quotes some very smart people who are bullish on commodities right now.
Some energy stocks look like real bargains. Barron’s is simply repeating the market’s conventional wisdom: After a brutal decline, oil prices are stabilizing and should head higher as the global economy recovers. That’s a perfectly defensible position – but I think it’s wrong."
We agree. He goes on to point out how the oil industry has changed in the last 10 years
and how the explosion of technology in the industry has forever changed not only the
dynamics of the business, but the economics as well. Bottom line, our oil companies are now
able to produce oil almost as cheaply as our friends (?) in the Mid-East and the OPEC
Barrons are kidding themselves to think they are in control of oil prices… the markets have
So What’s Next for Oil Prices? My favorite read recently has been the second quarter reports
of the U.S. oil companies. Anyone who believes that oil prices will rebound north of $50 per
barrel just needs to read the production reports and the cost control advances being made by
the U.S. oil industry!
Exxon: “Upstream production volumes of 4 million oil equivalent barrels per day were
3.6% higher compared to a year ago and liquids volumes were up nearly 12%.”
Occidental Petroleum: “Our second quarter production increased to 658,000 BOE
(Barrels of Oil Equivalent) per day, an increase of 13% with 78% of the increase from
Anadarko Petroleum: “Increased year-over-year oil sales volumes by 42,000 barrels per
day… we see our oil production going up through the balance of the year.”
Continental Resources: “…our production averaged a record 226,000 barrels of oil
equivalent per day for the quarter, up 10% over the previous quarter and 35% over Q2
Devon Energy: “Total oil production averaged 270,000 barrels per day, a 32 percent
increase compared to the second quarter of 2014.”
Hess Corp.: “Net production averaged 391,000 barrels of oil equivalent per day, an
increase of 23% from pro forma production in the year-ago quarter.”
We could go on and on… there are over 150 publicly traded companies actively drilling for oil in
the U.S. and many private firms. Most of them are reporting similar results… these are just
some of the bigger ones. Economics 101 teaches us that prices do not go UP while
production is still going DOWN.
My Prediction: Oil prices will go lower, probably much lower, and the stock market will not like
it, so I am expecting more of the roller coaster for the remainder of this year. While China and
the emerging markets will probably cause some of the volatility, I don’t anticipate much harm
to our economy (and another recession right here). Their problems could cause the Dollar to
continue its climb and some additional pressure on the companies doing business outside the
U.S., but I believe that cycle has just about run its course.
The Good News. The benefits of lower oil prices shouldn’t be far away. As the lower prices are
felt by the consumers and they begin to have confidence that the lower prices are here for a
while, they will begin to spend their money on other products… cars, houses, electronics, etc. I
believe housing is the one to watch because there is much pent-up demand by Millennials who
have been putting off home ownership since the Great Recession and housing has a huge
impact on our economy.
That’s why I believe we will avoid the recession for now…the amazing U.S. consumer will ride to
the rescue again.
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