Talk about doom and gloom. Oil bears are predicting $40 per barrel, even $30 per barrel. Meanwhile, a whole lot of folks are treating the chatter like it is a foregone conclusion.
What would need to happen for oil to go from $110 per barrel at the height of Russia-Ukraine tensions down to $30 per barrel and stay there? Oil-producing exporters would need to vow never to cut production… ever. Countries exceptionally dependent on oil revenue (a la Russia) would need to accept their financial strife, rather than decide upon any form of military engagement. Central banks around the globe would need to decide that they are no longer interested in fighting against a deflationary spiral. And hell would need to freeze over, since demand from every corner of the earth would need to disappear entirely.
Obviously, economic hardship across the globe has been a damper on demand. Clearly, the decision by producers around the world to keep producing, coupled with increasing oil production capacity in the United States, increases supply. It follows that the laws of supply and demand are not favorable for the near-term direction of oil prices. Yet even if a future shock emulates 2008’s systemic breakdown of the financial system or resembles 2011’s sovereign debt crisis in the euro-zone, an oil price collapse would recover to levels that reflect cyclical changes. In other words, oil could momentarily see $120 or $40, but you should be thinking $80 per barrel.
What can you do in the meantime? Some folks are suggesting that you abandon energy ETFs. In theory, those that have been long funds like SPDR Select Sector Energy (XLE) probably should lighten up, though they would have been better served by selling XLE in September when the price moved below and stay below its 200-day trendline.
Yet before repudiating everything associated with energy – from hybrid and electric car makers to drillers to energy infrastructure – one might want to revisit the notion of longer-term “value.” In particular, I am thinking about the integrated corporations like Exxon Mobil (XOM) and Chevron (CVX). Not only are they high-yielding stocks with 3%-plus yields – not only are they dividend aristocrats with 25-plus years of increasing their dividend payments – but ExxonMobil’s CEO recently explained that they are positioned to succeed at oil prices between $40 and $120.
Form a fundamental standpoint, P/Es below 12 and P/S ratios near 1.0 for both corporations are remarkably favorable. The broader stock market is pushing valuations that defy common sense, yet enjoy the tailwinds of easy monetary policy, low rates, technical uptrends as well as relative strength.
I am not saying that XOM is destined to pop in a Santa Claus rally. It’s a valuation play in the Warren Buffett mold as well as a contrarian selection in an unpopular space. It may be below its 200-day moving average, but it even has a series of higher lows in 2014 – something that you cannot say about the broader energy play in XLE.
In truth, Chevron may be a little bit riskier and a little bit trickier. Yet it is still a high-yielding dividend aristocrat with an attractive valuation. What’s more, you could not ask for more cash on its balance sheet. If oil gets much uglier, it might be able to make strategic acquisitions in the oil and gas space. (They’d do that, of course, because they realize oil will eventually recover to more favorable levels (i.e., $75-$80 per barrel.)
Naturally, if I am dead wrong about every last aspect of the near-term or long-term future for the energy sector, I am able to reduce the risk of loss with stop-limit loss orders. Moreover, as the creator of the FTSE Multi-Asset Stock Hedge Index, I have yet another tool in the protection shed.