Insights & Advice

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The tail that wagged the dog

Rarely do we see a single financial asset, in this case oil, have the ability to sway the prices of trillions of dollars worth of investments on a daily basis over such a prolonged period of time.

Oil has been in a multi-month tailspin. Its decline was supposed to be a good thing for most consumers, governments and markets worldwide. Why, therefore, has oil’s plunge had the opposite effect?

The answer depends on the reader’s time horizon. If you are the type of investor who trades with “high frequency,” as do almost 70% of market participants these days, then your concern is how much you can make or lose by the close of the day. The price momentum of oil is clearly to the downside (interspersed with short, sharp relief rallies). When you ride a successful trend like that, momentum becomes a self-fulfilling prophecy. Declines begat further declines and where it stops nobody knows. Technical analysts say the next stop on oil prices is $40/bbl. Until then, shorting oil and anything oil-related is what is called a “no-brainer” in the trade.

But wait a moment, if cheaper energy is good for most global economies, stocks, etc., why are they falling in price as well? The simple answer is that the benefits of sustainable lower energy prices are longer-term in nature. That’s why the Fed ignores the short-term price gyrations of energy or food in its inflation calculations. All too quickly what came down, goes back up.

The market knows this but chooses to ignore it. Consider December’s “disappointing” retail sales data. The Street had convinced itself that Christmas sales should be terrific simply because oil prices were dropping. Consumers would (so the story goes) take every dime saved at the pump and immediately go out and buy holiday presents (ala Scrooge) for one and all. As a result, retail stocks soared in early December. Analysts were falling over themselves hyping the sector and short-term traders made money.

Did anyone bother to ask whether consumers might have other uses for those windfall savings? Maybe paying down debt or actually bolstering savings might have taken priority over a new computer or television. Consumers, like the Fed, have seen pump prices rise and fall many, many times in the past decade. Clearly, those energy savings, if sustainable, will translate into higher spending over time but the real world operates under a different time schedule than Wall Street.

For those who have a longer-term time horizon, however, theses short-term traders are creating a fantastic buying opportunity for the rest of us. And I don’t mean by just buying a handful of cheap oil stocks either. You will have plenty of time for that. So many pundits are trying to call a bottom on oil that the only things I am sure of is that we haven’t reached it yet. And what if we do?

I was around for the mid-1980s oil bust when the price of oil fell 67% between 1985-1986. It took two decades for oil prices to regain their pre-bust levels. Sure, energy stocks were cheap but they remained cheap while the rest of the stock market made substantial gains. Why take a chance on picking a bottom if your only reward is a dead sector for years to come?

Why not look to buy long-term beneficiaries of a lower oil price in areas such as industrials, technology, and transportation and yes, consumer discretionary? In the short-term, have patience because as I have said I believe the markets will decline in sympathy with oil until we reach at least that $40/bbl. number. After that, by all means, do some buying. I know I will.

Posted in A Few Dollars More