WMA Cara Report for week ending January 12, 2018
  • January 14, 2018 05:22 pm
  • by Bill Cara

Market Leadership In 2018 To Come From Oil & Gas


The thirty-three (33) Oil & Gas companies of the S&P 500 will lead that important benchmark, maybe not during January, but through 2018 and beyond. The reason is simple. It’s all about revenue, cash flow and earnings growth on account of higher Crude Oil prices, rising to the level where this crucially important industry is now achieving sustainable economics.

The Oil narrative is changing. No longer is the industry full of doom and gloom.

Investors who study a company’s fundamentals before taking positions in stocks got on board early. Trend followers have now gotten the message and are becoming invested. At some point this year, the public will follow. Oil stocks will lead the S&P 500 by the end of 1Q2018.

The broad issue to consider at present is why is investor sentiment changing 180 degrees to now favoring Energy.

For starters, the World Bank is estimating that the global economy is growing now at +3.1% annually. Rapidly growing economies need increasing amounts of Oil. Since 2014, however, producers of Oil severely held back their capital expenditures for exploration and development, to unsustainably low levels. So, with demand on the rise and supply being constrained, especially with production cuts agreed by OPEC + Russia, at some point the $WTI and Brent Oil prices had to rise. They have been since the summer of 2017, doubling to the $63-$69 level, which is now impacting corporate operating results quite significantly.

We know that as the S&P 500 rises, the leaders are always winners while the laggards could be losers unless new money is brought to the table during periods of monetary expansion, in which case even laggards can be winners as witnessed since early 2009. As we say, a rising tide floats all boats.

However, we are now wary because the highly favorable market conditions experienced since 2009 are unlikely to continue. That’s because G-20 central banks are now in a monetary contraction cycle and we expect them to remain so through 2018-2020. Policy reversals of this extent require a radical change in our thinking. The squiggly line era of blindly chasing momentum stocks is over, replaced by analysis of the factors that truly drive market prices, which happen to be corporate fundamentals.

From consensus earnings estimates, it appears that S&P 500 components will grow their earnings +13.7% in 2018 over 2017 and +9.5% in 2019 over 2018. The Dow 30 companies are projected to grow earnings by +11.4% this year. The public is impressed. The broad market indexes are rising.

However, the S&P 500 figures include the 33 Oil & Gas companies that are expected to grow their earnings by an average +65.5% and +25.6% respectively, which is significantly better than the rest. Therein lies the important story.


That outstanding turnaround for these 33 large cap Oil & Gas companies (the average market cap is $44.7 Billion) is the reason that Energy is going to be the go-to sector for this year.

Given the approximate overall 20% weighting of the S&P for Oil & Gas, it means some other industries will be growing their earnings at well under 8% and 6% over the next two years even with solid economic expansion. And, even the anticipated 2018 earnings increase of +25.7% for the vaunted Fab Five (AAPL, AMZN, FB, GOOGL and MSFT) cannot compare to +65.5% for the S&P 500 Oilers.

Since asset allocation is our principal focus, meaning we seek to buy stocks of industries whose fundamentals are improving and sell those that are weakening, we are already invested in Oil & Gas. Since we started our Natural Resources Fund in September 2017, we are pleased to report that this account is up some +20% in just 18 weeks.

In addition to our Fund’s holdings of Oil & Gas, other industries include at times Chemicals and other Basic Materials, Forest Products, Precious and Industrial Metal Miners, and Alternative Energy including Coal, Uranium and Solar. These are industry groups whose stocks usually benefit when Inflation rises.

Today the US reported that Core CPI ticked up +1.8% Y/Y versus the expected gain of +1.7%. That’s not much, but the news added to the narrative.

There are, of course, many factors that go into stock selection. In our case, each week we examine over 20 fundamentals-based data-points for 3734 companies, weighting some values much more than others depending on the portfolio. We then rank each company from 1 to 3734.

The subset of our investible universe for Natural Resources numbers 210, with about two-thirds of these in Energy.

Interestingly, our fundamentally top ten ranked Oilers have consensus earnings estimates that analysts expect to grow +48.1% this year, which is more than the Fab Five technology companies but less than for the 33 S&P 500 Oilers. However, on average, we consider this top ten list to be financially stronger companies than the other Oilers, and even the Fab Five, at least in our eyes.

In fact, our Top Ten ranked Oilers have an average fundamentals-based ranking of 52/3734, which is outstanding, while the 33 S&P Oilers average 1376/3734 and the Fab Five average 459/3734, both not nearly as good.

Not all our top ten ranked Oilers are invested in our Natural Resource portfolio today or even on our “To Buy” list because we do not consider them at this point to be good value relative to price. You see; other investors also research and make decisions on data-points like ours. So, even though we try to buy into cyclic weakness, often the market will not give us the price we want, and we move on to analyze other companies and their stock prices.

Some Oiler stock prices are attractive today, particularly a few of the Canadian Oilers that had suffered immense price declines since 2014. After WTI collapsed, investors were very concerned about large debt loads of the companies, but we do not see that as a problem now. After taking profits to raise about 30% cash for the Fund in late December, we still hold Baytex (BTE) and Crescent Point (CPG).



Crescent Point

With the recent Oil price increases that confirmed our outlook since last summer, our views on earnings of many Canadian Oilers are quite different to most industry analysts who follow them. Maybe we are right and maybe the analysts are.

In general, we believe that buy side investment analysts are typically late in changing their conservative opinions following long-cycle trend reversals, mostly because it takes time for corporate financial data to accurately reflect changes in business conditions. The fundamentals of the two Canadian Oilers whose shares we still hold (BTE and CPG) in fact rank poorly on anybody’s scoreboard, but we feel that is acceptable as long as our overall average portfolio ranking remains good, and it does, and our investment performance is good, and it is.

COT data, you should be aware, shows that Commercial and Large Speculator Traders are now holding extremely high levels of Oil contracts. That potential profit-taking situation is a warning, so we are anticipating short-term resistance to the recent run-up in WTI and Brent prices, which ought to shake out some of the weak hands that are holding Oiler stocks. In fact, in anticipation of this shift, we sold large positions in our Oilers in late December and have been awaiting attractive price levels to buy them in again this quarter.

At the end of the day, successful portfolio management is about achieving good investment results. As noted, Energy has recently played the major role in our Natural Resource Fund’s solid performance and we expect more good news to come for Oiler investors in 2018. Of course, stock selection and well-timed trading decisions are required.

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