A long way to go for oil and a long way to go to the bottom for the stock market

A long way to go for oil and a long way to go to the bottom for the stock market

01 August 2022 from Mikael Syding

The price of a barrel of WTI oil has increased by 10% in just two weeks since my last article. There has been a general bull in July, a classic summer rally, and the oil companies were allowed to participate despite being labeled as pariahs by ESG supporters. My personal favorite among the majors in the sector, ConocoPhillips (COP) has risen from $78 to $98 per share. Exxon is further up today to 97.50 and Chevron 164. Last time I wrote that at least one doubling was justified unless the conditions in the world suddenly changed drastically. That means if I am correct there could be further upside from here to fair value.

The best thing about investing in oil stocks is that it is an asymmetric bet on inflation and supply shortages, where too little supply leads to higher oil prices and bigger profits for the oil companies, while the rest of the economy has less money left over after energy costs and can therefore be forced to suffer through a profit recession. Extremely cheap oil stocks (about 6x earnings per share after tax) then face profit revisions and capital inflows from other investments with high valuations and lowered forecasts. As the oil sector moves from being undesirable because it is not ESG, to being a safe and cheap haven for investors in troubled times, valuation multiples have the potential to go from low to reasonable and possibly further to unreasonably high. It would be a completely normal reflection of when the tech sector made the same journey relative to energy in the last 20 years.

But just because oil shares could be cheap and relatively safe does not mean that an investment in them is "safe" - especially not in the shorter term than, for example, one year. Right now the summer rally is in full swing, but it could be just a pause in a falling trend. I estimate that there is about half of the rally left, i.e. maybe about the whole of August. The reason I dare to believe in another full month of positive stock market development is that we have put both Thursday's Fed meeting behind us (with six weeks to go), and the most important part of the reporting period for the second quarter.

As expected, the Q2 reports were better than the market had priced in due to all the interest rate hike and recession talk. Of course, increased interest rates do not have an impact so quickly, but it is in the coming quarters that the effects can begin to be seen and communicated in the companies' official guidance for 2022 and 2023. This is when the profit estimate must be revised down, while the multiples may fall further due to the higher interest rates and lingering inflation. But we are not there yet. Now, it's still only August 1st and maybe a month of rallying to go before the worries of fall come close enough to cause concern in the investor ranks.

Just as in previous difficult times for the economy, the stock market exhibits a long and steady downward trend, occasionally interrupted by intense upswings, so-called BMR: Bear Market Rallies. A characteristic of a BMR is that what has fallen the most also rises the fastest. This means that not least the shorter ones who, with the utmost justification, are short expensive companies with questionable or negative cash flows can find themselves in a pinch when FOMO (Fear of missing out) and short covering lift these particular shares a little extra high. The hydrogen energy company Plug Power and the movie theater chain AMC are two good examples, but there are many more that I have mentioned in previous articles, e.g. Tesla and Snowflake.

In short, you can summarize the situation by saying that everything is going well now, but this autumn, rising energy costs, increasing conflict with Russia and signals of an increasingly gloomy outlook for the companies' accounts and, at the same time, continued interest rate increases from the Fed may cause a sharp stock market decline to new lows for the year. It is important to avoid getting caught up in the rise of expensive technology companies, but to sell them if you happen to have some Black Peters left in the portfolio, and instead dare to accumulate shares in other companies, for example oil companies, on weak days. When the recession comes, the magnitude of the downside for the most hyped tech companies may surprise even more than the strength of the ongoing summer rally did.

However, the most important thing in the end is not to time the downward turn after the BMR. No, it is to have dry powder to be able to afford to position oneself strategically and long-term in value-creating, creative companies for the next big upswing market, perhaps between 2024-2030. In order to do that, to begin with, you must not lose too much in the fall race, but above all you should have a plan for what to buy and roughly when to start doing it. The oil companies, for example, are already very affordable and have excellent future prospects. If you have a high tolerance for fluctuations, uranium companies are also an excellent addition to the energy portfolio. The upside is much greater than for the largest oil companies, but of course the risk is also much higher.

In my private crypto chat I wrote on June 30th on a question about cryptocurrencies that I thought BTC and Ether would go up around 50% in July and then down -50% this fall. I have revised up the upside a bit, with "targets" of $30,000 and $2,000 respectively, but still believe downsides of roughly -50% from there in a risk off scenario when the stock market may crash this fall/winter led by tech companies. In practice I hope to buy Bitcoin at maybe as low as $12,000 and Ether at $750 when it looks darkest. But in order not to miss the situation completely, I may start buying even at higher prices.

At some point in Mårran's cold shadow, I also want to start buying "wonderful companies at wonderful prices" - timeless favorites exemplified by Intel, John Deere, Evolution gaming, Unilever and LVMH. My suggestion is that you start building your own list of companies today, which, when they become cheap enough, are worth accumulating with leverage in 2023. I don't think you have any longer than that before stimulus before the US presidential election in the fall of 2024 kicks in. But earlier than the turn of the year 2022/2023, the fear of the combination of tightening from the Fed and falling profit forecasts does not have time to work its way into panic sales and the final stock market bottom. I would aim for about April-May 2023 for the ultimate bottom scratcher. Incidentally, it would be fast enough with only a sixteen-seventeen month decline for a bear market after thirteen years of central bank manufactured mega-boom.

The key to where the tipping point will be is either if the stock market gets cheap enough on its own, or when there are signals that the Fed is about to give up, i.e. Powell doing a repeat of his sweet pirouette in the fall of 2018. As long as PCE inflation (Personal Consumption Expenditures Index) is above 4% and as long as the funding source of the zombie companies does not freeze to ice, the Fed will not change its strategy. The corporate bond market usually has its worst period of the year in October/November, partly due to year-end effects which are then close enough to have an impact. The Fed must first show the Democratic voters that inflation must be fought for the sake of the people and preferably at the expense of the capitalists. In addition, the Democrats want the interest rate as high as possible before the presidential election campaign so that it can be lowered as much as possible to create positive momentum in the economy. Simply voice fishing. So if a pivot happens in the fall, the stock market can turn up in the spring.

The above reasoning means that a conceivable bottom possibly in the most positive of worlds could already be reached sometime now between November and January. But I rather believe that weak Q4 and Q1 reports with a negative outlook and forecast guidance mean that the stock market finds its lowest level a few more months later, i.e. in the spring of 2023.

The bottom thus becomes sandwiched between the earnings recession that has not yet begun and the 2024 presidential stimulus (of which interest rate cuts may form a central part). The market is usually able to detect such reversals about six months in advance. In addition, the stock market has shown a fairly stable pattern with the Christmas rally late in the fall. However, this year's autumn has probably already passed, and next autumn it may be too late to catch up with the absolute lowest share prices. The dip buyer mentality is probably too strong among today's investors to wait that long. All that remains is to buy in weak months throughout 2023, perhaps especially in April-May, with a lot of ice in the stomach and eyes firmly fixed on the following year for the real reward.

The second half of 2024 could turn out to be spectacularly good, as all planets seem to align for massive gains in risk assets like stocks and cryptocurrencies. This probably also applies to gold, because when the Fed gives up on inflation control while the presidential election is about to be greased with free money and the memories of 2022 start to fade, FOMO and the Christmas rally could combine for a perfect fall storm. Your most important job is to navigate the next twelve months so you have as much liquidity as possible left over to buy for, once we've put this year's summer rally and winter apocalypse behind us.

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01/02/2023 12:49:24


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