Turning Point in the Energy War? By Lewis J. Walker, CFP(R)

Ken Follett’s sweeping novel, Fall of Giants, chronicles events in Europe leading up to and through World War I. With fiction interlaced with actual historical characters and events, the book underscores a recent comment by writer Matt Litchfield concerning financial stocks: “The one error that both investors and generals often commit is a tendency toward always fighting the last war.” (“Fund Flows: Bank on Insurance Sector,” moderntrader.com, 5/16).

Litchfield noted the 2008 carnage in financial stocks that continues to plague the psyches of investors. In late February of this year, investors feared the Fed had been too hasty in hiking interest rates in December and the Ghost of 2008 yelled, “Boo!” The price of Bank of America stock (BAC) and Citigroup (C) fell to about ½ of book value. Said Litchfield, “The market was so terrified about a replay of 2008 that it priced the banks just below the going rate for China’s undercapitalized and overly stressed ‘Big Four’ banks.” Blue-chip American banks selling for less than Chinese banks? “If that’s not an example of ‘blood in the streets’ I don’t know what is,” observed Litchfield. I do remember one client asking why a value-driven manager owned BAC and one can see why in the midst of a February slump a person might ask why such a “poor performing” name was in the portfolio?

Since the February low, both BAC and C are up in value substantially, by about 34%. Litchfield sees similar opportunity in unexciting insurance company names which have taken a beating given low interest rates. We make this point not as a market forecast or to tout specific stocks or sectors, but to illustrate how tough value investing can be at times. For those who remember painfully “the last war,” it is hard to wade back into “no man’s land” to seize new positions, or even “seize the day.” Carpe diem? Non certe!

Are we seeing something similar in the oil patch? It may be hard to tell but in recent trading days the “lockstep” between the rise and fall in oil prices and stock prices seems to have been broken to some degree. A 4/21/16 The Wall Street Journal story headlined, “Oil Companies Hit Pay Dirt.” Investors are buying newly issued stock in energy companies! We have seen private equity banks pouring impressive sums into the energy sector looking for bargains amongst the stressed.

In the first quarter oil dropped to $27 bbl., a price lower than during the 2008-2009 global crisis. By April 21, 2016 it was back to $42.63. In an April 19, 2016 commentary, portfolio manager Paul D. Strand of Alliance Global Investors noted that with production falling and demand expected to grow, inventories should decline and prices rise. Strand sees oil in the mid-$50s as the “right price.”

Investors have been fixated on oil prices and the dance in the stock market while under embracing the fact that low energy prices are good for most of the economy. However, cheap energy will not last forever. Strand notes that exploration and capital expenditures in the U.S. dropped 35% in 2015, and are expected to fall another 50% in 2016. Rigs drilling for oil in the U.S. dropped by 76% in the last 18 months. This is a massive decline in energy development and investment. Not good for energy independence! For bargain hunters...perhaps?

Obviously stocks are volatile and should be part of your longer term growth portfolio, consistent with your ability to assume risk, other sources of liquidity and income, etc. The point is that in a market which some say is expensive and fully priced, the hunt for bargains requires patience, a good eye and lots of data, and a willingness to be wrong in the short run, whatever that is. If it was simple, “it” wouldn’t be a bargain for long!

Lewis Walker is President of Walker Capital Management, LLC. Securities and advisory services offered through The Strategic Financial Alliance, Inc. (SFA). Lewis Walker is a registered representative and investment adviser representative of SFA which is otherwise unaffiliated with Walker Capital Management, LLC.