“Markets Routed in Global Sell-off,” was the banner headline of the Financial Times this week. It seems like anything that can go wrong will go wrong. It’s Mr. Murphy’s market, right?
How bad can it get? It’s already bad, but can it get worse? Markets go up and they go down. That’s what markets are all about. Still, it’s one thing to live through a market pullback or correction. It’s another thing entirely to experience a total rout. It’s like what happened during Napoleon’s retreat from Moscow. There’s no relief from the suffering.
Evidently, the world wants its money back. It’s selling. In fact, a lot of people want out of the market right now. Are you one of them? I don’t blame you if you are looking for a way to bail out. But before you pull the “Eject” handle, let’s think this through.
Sure, it’s easy to wish that you sold your stocks six months ago. But you didn’t. Neither did I – at least not all of them. Why didn’t we sell? Were we focusing too much on the long term? Did we miss some sell signal? Where’s that bell that they’re supposed to ring at the top of the market? What the hell were we thinking, that we’re bulletproof or something? Well, before we get too far ahead, let’s look back and see how we got here.
From the end of 2006 to July 2008, oil steadily increased in price:
Also, between late 2006 and July 2008, the U.S. dollar declined in value, particularly against the euro.
Both run-ups – in the price of oil and the value of the euro against the dollar – were too much, too fast. The apparent strength in both oil and the euro (and the weakness of the dollar) masked the fact that the trading numbers were outrunning the pure economic fundamentals.
Here’s the key set of points. The eurozone economy was not that good last year. The dollar and the U.S. economy were just not that bad. Oil was just not worth that much. Despite the Peak Oil thesis – in which I believe strongly – the world really wasn’t coming to an end last summer. (And it didn’t.)
So by this past July, oil was too expensive and the dollar was too cheap. I said so both in writing and on Fox Business News and other media. As you can see from the charts, by the second week of last July, oil was selling at $147 per barrel and the euro was over 1.6 relative to the dollar. Too much.
What happened, then? In mid-July, the U.S. dollar began to strengthen, due to central bank intervention. And the price of oil fell. Both changes were rapid, even abrupt. A surprise? No, not really.
I expected the dollar to strengthen, and I said so. And I expected the price of oil to decline from the $140s to about $100-110 per barrel, with a possible excursion down into the $90s per barrel. I actually thought that a stronger dollar and declining oil prices would be “good” for the overall world economy, because this would leave more money in the pockets of consumers – especially energy users.
But now in hindsight, it appears that the run-up in oil prices from 2007-mid-2008 sapped household and consumer income across the world. The oil run-up and simultaneous dollar devaluation were enough to trigger the mortgage crash. Of course, the mortgage crash was coming, and it was always just going to be a question of causation. Now it’s up to history to assign naming rights to the meltdown.
Let me use a different analogy. The dollar decline and energy run-up did not give just a chest cold to the world’s credit-driven economy. The yearlong decline of the dollar and rising oil price gave the world economy a case of tuberculosis. And it’s a strain of TB that is resistant to all the usual antibiotics.
So here we are. The world economy is sick. And I mean really sick. The markets are coughing up blood. None of the usual remedies will work. There’s no magic pill. From here on out, it’s trial and error. It’s hit or miss. And the prognosis is grim.
Let’s get back to whether or not to sell your stocks.
First, I’m certain that it’s painful for you to watch your investments decline. You worked hard for the money with which you bought stocks over the years. And now the value of those stocks is falling. It just stinks.
This market meltdown is not like Goldilocks sneaking into your kitchen and eating your porridge. No, this is like Goldilocks breaking into your house and burning the place down using magnesium flares as accelerants. Years of hard work are just turning into smoke and ashes right before your eyes.
I have to say that declining markets are plenty painful for me. It hurts twice as much because I edit Outstanding Investments. That is, I have both money AND a reputation at stake in this process. Agora Financial does not give out personal investment advice. But the last thing I want to do is offer up a bum steer when it comes to helping you make your financial decisions.
My newsletter has a straightforward investment thesis. We invest in energy and resource plays because over time – we believe – energy and resource investments will become more valuable. There are a number of reasons for this, including geological scarcity, past underinvestment and increasing future demand. But it’s a basic idea, and we think it works. At least, it has worked for the past six years or so.
For the past few years, we have been selecting investment ideas in companies that appear to have bright futures in a looming era of rising energy and resource demand. And many – most, really – of the investment ideas did well. Some did very well. A lot of readers made a lot of money. Whether it was oil, gold, refineries, cement or energy infrastructure, it seemed like we were investing in places where the world was going. Right?
But now it seems like the investment locomotive – energy, resources and related infrastructure – has derailed. Energy prices are declining. Energy-related stock plays are down. Commodities are down. Mining and infrastructure stocks are in the dumps. The falling tide is leaving us high and dry.
But does that mean that our whole investment thesis is unraveling? Not so fast, pilgrim. Let’s keep on thinking this through.
Before you do anything precipitous – like sell your last stocks and stuff the cash into your mattress – let’s ask a few more questions.
If you sell out now, what price will you get? A low price, right? So if you sell now, you will leave a lot of value on the table. That is, most things in the world of energy and resources are underpriced compared with their intrinsic value. I don’t care how bad the market looks just now (and it looks awful). Go out and try to find an oil field somewhere, or build an oil refinery, or find an ore deposit and build a mine. Can’t do it, can you?
So if you sell out now, just be aware that you will be getting a relatively low value. You will be leaving long-term value behind. If that’s what you want, then that’s what you ought to do. Just understand the point.
Which brings up the next set of issues. How badly do you need the money? How soon do you need it? How scared are you of further declines? How much risk can you handle, especially going forward? What kinds of reassurance do you need?
The markets are down. A lot of Elvises have left the building. And who is left to do the selling? Just you? Nope. Whatever you think, you are not alone. There are still a lot of people holding their shares. What do they know? And what is their reasoning to hang on?
From what I have seen, the biggest sellers – the market drivers who are taking the express elevator down to the subbasement – are people who have lost control of their money, if not their investment destiny.
People are selling to meet margin calls. The wildest sellers are traders who are just plain behind the eight ball. It’s more than being scared by what is happening. Heck, we’re all scared in some way or another. I wasn’t around in the 1930s, so I have no firsthand experience with the Great Depression. I know only what my parents and other relatives and friends told me. It was pretty bad for a lot of people.
But right now the serious sellers are people who cannot afford to be patient. A lot of the sellers in the energy and resource field are hedge funds. These firms are meeting redemption calls from investors who want out. The hedge funds just plain need cash. They have to sell. And a lot of those funds are throwing everything over the side, even the life rafts and the emergency rations.
When you look in the mirror, is that you? Are you like a hedge fund in panic mode, selling everything just to raise cash? Do you fit into this “sell-sell-sell” model? Don’t feel bad if this is what you have to do. Just be honest with yourself.
Meanwhile, the U.S. – and the world, really – has been dealing with a credit crisis for over a year. Which makes me wonder if there is a turnaround coming sooner, rather than later. I don’t know that. I don’t have a copy of the Financial Times from next March. So I just cannot say if we are closer to the bottom than to the top.
How soon do you need your funds? If you need cash within the next 12-24 months to pay bills like those for college tuition or a nursing home for a relative, then maybe you ought to just take the hit and get out of the market now. There’s no shame in being safe. Look after your needs.
But do you have a longer horizon? Are your “down” stocks in your IRA or 401(k)? You can’t take it out without penalty until you are 59 1/2 years old. Then consider riding it out. And maybe with these low valuations on most stocks, it’s even time to go shopping – but certainly not blindfolded. Nibble away.
In a lot of respects, the world is on sale right now. Heck, a lot of stocks in the OI portfolio have turned into dividend plays. Can they maintain their dividends? That’s a good question. Can they sustain earnings? At the same time, if you were management at these companies, would you risk further tanking the stock by cutting the dividend?
And let’s look ahead a year or two. Commodities in general have been plunging in price since early July. The dollar has been strengthening. Will that continue? Can it continue? Why should the dollar stay strong? Does the number $700 billion mean anything to you? So sure, the strong dollar can continue and commodity prices will stay weak. But at some point, the dollar will start to decline in value. And commodity producers will have to cut back on operations by closing mines and mills and smelters. Then they regain pricing power.
And if the world has the vast recession that many people are forecasting? Then global demand should decline in the near and further future.
But there are 6.5 billion mouths to feed on this planet. The world will still have to produce a lot of materials to satisfy basic demand. That is just built into the equation of human survival. And what will happen to pricing power as some layers of high-cost output go away?
For example, the world petroleum industry will lift over 31 billion barrels of oil this year. Even if world demand dropped by, say, 5% – as if the world airline industry simply vanished – the world would still lift nearly 30 billion barrels. And as the current economic woes cause new projects to slow, annual depletion will overwhelm annual new output from new fields. There will be less oil.
That is, looking ahead, the world may never again exceed the oil output levels that we will have in 2008. Indeed, it will require heroic efforts just to keep global oil output flat in the future.
So this brings us back to that OI investment thesis. Energy and resources are getting scarcer and ought to become more valuable going forward. Hey, too bad the world financial system is busted. But that just means that there’s an opportunity to buy good stuff really cheap.
No, I’m not saying that you ought to go out and buy stock with both arms or back up the pickup truck and start shoveling. You need to be very cautious right now. But don’t panic, either.
Sell if you need to sell. Buy if you want to take on the risk. We’re in for some rough economic times. But unless world population starts to die off fast or people develop a taste for living low and being cold a lot, the energy and resource plays are still going to work over the long haul.
Until we meet again…
Byron W. King
for Markets and Money