The Crouch Connection

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

stock markets).

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

taken over!

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

oil.”

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

2014.”

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.

"The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Any opinions are those of the authors and not necessarily those of RJFS or Raymond James. Expressions of opinion are as of this date and are subject to change without notice. The

Dow Jones Industrial Average (DJIA), commonly known as “The Dow”, is an index representing 30 stock of companies maintained and reviewed by the editors of the Wall Street Journal. The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. Keep in mind that

individuals cannot invest directly in any index. Keep in mind that there is no assurance that any strategy will ultimately be successful or profitable nor protect against a loss. Past performance may not be indicative of future results."

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