Crude and Late Economic Cycles
Last week we had a look at late cycle base metals outlook. We have not done a deep dive on our long term energy outlook for a while. We thought that it would be timely this week with heightened focus on OPEC, Russia, and Venezuela supply and demand while the US is now the largest producer in the world and Canada is rapidly losing global prominence due to the flawed leadership of the Liberal governments federally and NDP governments in Alberta and BC. We do not see a material change for Canada unless we see a shift to a government that understands that we need to balance economic and environmental considerations. The good news for Canada is that we expect a change of government in Alberta and federally. Longer-term, the world is serious about reducing the carbon footprint and the Canadian markets will likely lag due to the fact that energy is such a huge weight. Currently, 18% of the S&P TSX is in the energy sector compared to 5% in the US and 5.85% in the world index. The Russian ETF (RSX) has 39.3% in the energy sector and the UK at 17.2% is similar to Canada. Norway is 30.8% energy. Not too surprising their sovereign wealth fund is divesting from the sector. The first chart shows the front month price of crude over the past 13 years and the second is the 5-year forward price over the same period. Looking back at 2012, the weight of energy in the world index was 10.7%, for the US it was 10.45% and for Canada it was 26.1%. I do not see a scenario where energy regains its leadership in the world as an investment theme.
Prior to the boom in fracking that really began to take hold around 2011 and over the last few years exploded to the upside in terms of production, the longer-term outlook was much more tied to the current price. In the past 5 years since US supply has increased rapidly and Canadian distribution has been choked off, the longer- term price has anchored around the $50-60 range. We see that continuing for the next 5 years and longer. The big question as always in the sector is depletion versus investment and the bigger picture supply demand factors. I see a future where all the cars and trucks in the world will have some combination of battery and other clean energy sources. I’m not sure airplanes will get there, but fuel economy improvements should continue. And even factoring in world population growth around 1% annually, peak demand for oil is closer than most would think.
We can see the shape of the forward curves changing over time in the following graphs.
Currently, energy is one of the biggest weights in my portfolios. There is a difference between investing for the long-term like Warren Buffett and shifting exposures opportunistically as I do. The energy sector is a bad long-term bet when you compare it to technology and consumer stocks in the coming decades. That debate would not last too long. For the next 5 years, US pipelines will be filed to capacity and beyond with the US now one of the growing exporters in the world. I’ve liked the value and yield of US pipelines (AMLP) in the past few years. So while I’m clearly a longer-term bear on the sector, and in the coming recession WTI will surely hit the $25-30 range again, we will see periods where the sector is tactically tradeable. I’m a buyer on dips in the sector (XLE), which is a US play. And if we see a change in government federally, which increasingly looks likely, we should see some of that land locked excess supply making its way to market (read more pipelines). At that point, Canadian energy looks to outperform for a while. And while I consider myself greener than average (I drive a hybrid car), balancing the economic impact and the environmental impact of investment in the energy sector is just the prudent approach– I’m pro pipelines for Canada. There is some value in the sector and so it’s tradeable, but I would not make a bet that we go back to the boom days for Alberta. Sorry!
Learn to Sleep at Night in a Bear Market
The previous Investor’s Guide to Thriving tour wrapped up on December 1st 2018. Aptly named “How Long Can a Bull Market Run?” we may have received our answer. The market printed the worst December since the Great Depression – bringing most of the major indices officially into bear market (-20%+) territory. Markets have rebounded in January as they always do after steep declines, but we are likely in the early phases of a bear market where average corrections are closer to 30% and extreme corrections are more than 50%. If this is case, we haven’t seen the last of market volatility and a downward pattern of lower highs and lower lows. Many people are surprised at this phase because it can take some time for the fallout to move from Wall Street to Main Street – showing up as a recession. Job markets are relative robust still and Central Banks are still talking about raising rates. Markets are forward looking and generally anticipate economic downturns, so even as rates continue to rise, employment appears to be strong, and many companies are still posting record earnings – you should be paying attention to the growing cracks in the system.
Larry will take the audience on a more detailed tour of past bear markets to see what we can learn about how this next one might compare. Will it be a gentle panda or a deadly grizzly? Can we hope for a soft landing due to aggressive government policy? How would we recognize a market bottom – when the next major bull market might begin? Why not go to cash or put all your money into a GIC right now? There are many questions to ask – and while (spoiler alert) we don’t have a crystal ball to give you the definitive answers, Larry can show you how to navigate a bear market so that you will use it as an opportunity rather than something to fear. Using some of his favorite indicators and techniques, you will learn how to use a tactical approach to trading, and strategic asset allocation (including the use of gold, real assets, and other non-equity vehicles), to help keep your portfolio within your emotional comfort zone – while avoiding costly emotional mistakes. Success in difficult markets is both a science and an art, so Larry will also discuss the psychological aspect of managing portfolios under stressful conditions.
You will take away from this live presentation a timely perspective on how to approach your investments in 2019 and beyond – along with actionable ideas to help strengthen your portfolio, and even a few tools and resources to use at home.
Click here to register for free and as always we ask for volunteer donations to one of our two favourite charities. Children’s cancer research at the Sick Kids Hospital and Alzheimer’s and dementia research at the Baycrest Hospital.