When Bad Things Happen to Good Investments, Part I

Welcome to Murphy’s Market.

If you sold out of the stock market last year — or even back in June or early July 2008 — you probably feel pretty good right now. And if you took the cash and spread it around to a group of well-run banks, so as to take advantage of the FDIC insurance, then you must be feeling fine. Read no further. Take the rest of the day off.

But if you still have some skin in the game, let’s talk.

“Markets Routed” — The World Wants Its Money Back

“Markets Routed in Global Sell-off,” was the banner headline of the Financial Times this week. It seems like anything that can go wrong will go wrong. It’s Mr. Murphy’s market, right?

How bad can it get? It’s already bad, but can it get worse? Markets go up and they go down. That’s what markets are all about. Still, it’s one thing to live through a market pullback or correction. It’s another thing entirely to experience a total rout. It’s like what happened during Napoleon’s retreat from Moscow. There’s no relief from the suffering.

Evidently, the world wants its money back. It’s selling. In fact, a lot of people want out of the market right now. Are you one of them? I don’t blame you if you are looking for a way to bail out. But before you pull the “Eject” handle, let’s think this through.

Sure, it’s easy to wish that you sold your stocks six months ago. But you didn’t. Neither did I — at least not all of them. Why didn’t we sell? Were we focusing too much on the long term? Did we miss some sell signal? Where’s that bell that they’re supposed to ring at the top of the market? What the hell were we thinking, that we’re bulletproof or something? Well, before we get too far ahead, let’s look back and see how we got here.

Looking Back at a Weak Dollar and Expensive Oil

From the end of 2006 to July 2008 oil increased steadily in price. Also, between late 2006 and July 2008, the U.S. dollar declined in value, particularly against the euro. Both run-ups — the price of oil and the value of the euro against the dollar — were too much, too fast. The apparent strength in both oil and the euro (and the weakness of the dollar) masked the fact that the trading numbers were outrunning the pure economic fundamentals.

Here’s the key set of points. The eurozone economy was not that good last year. The dollar and the U.S. economy were just not that bad. Oil was just not worth that much. Despite the Peak Oil thesis — in which I believe strongly — the world really wasn’t coming to an end last summer. (And it didn’t.)

So by this past July, oil was too expensive and the dollar was too cheap. I said so both in writing and on Fox Business News and other media. As you can see from the charts, by the second week of last July, oil was selling at $147 per barrel and the euro was over 1.6 relative to the dollar. Too much.

What happened, then? In mid-July, the dollar began to strengthen, due to central bank intervention. And the price of oil fell. Both changes were rapid, even abrupt. A surprise? No, not really.

I expected the dollar to strengthen, and I said so. And I expected the price of oil to decline from the $140s to about $100-110 per barrel, with a possible excursion down into the $90s per barrel. I actually thought that a stronger dollar and declining oil prices would be “good” for the overall world economy, because this would leave more money in the pockets of consumers — especially energy users.

But now in hindsight, it appears that the run-up in oil prices from 2007-mid-2008 sapped household and consumer income across the world. The oil run-up and simultaneous dollar devaluation were enough to trigger the mortgage crash. Of course, the mortgage crash was coming, and it was always just going to be a question of causation. Now it’s up to history to assign naming rights to the meltdown.

Not Just a Chest Cold — a Case of Tuberculosis

Let me use a different analogy. The dollar decline and energy run-up did not give just a chest cold to the world’s credit-driven economy. The yearlong decline of the dollar and rising oil price gave the world economy a case of tuberculosis. And it’s a strain of TB that is resistant to all the usual antibiotics.

So here we are. The world economy is sick. And I mean really sick. The markets are coughing up blood. None of the usual remedies will work. There’s no magic pill. From here on out, it’s trial and error. It’s hit or miss. And the prognosis is grim.

Investment Pain

Let’s get back to whether or not to sell your stocks.

First, I’m certain that it’s painful for you to watch your investments decline. You worked hard for the money with which you bought stocks over the years. And now the value of those stocks is falling. It just stinks.

This market meltdown is not like Goldilocks sneaking into your kitchen and eating your porridge. No, this is like Goldilocks breaking into your house and burning the place down using magnesium flares as accelerants. Years of hard work are just turning into smoke and ashes right before your eyes.

I have to say that declining markets are plenty painful for me. It hurts twice as much because I edit Outstanding Investments. That is, I have both money AND a reputation at stake in this process. Agora Financial does not give out personal investment advice. But the last thing I want to do is offer up a bum steer when it comes to helping you make your financial decisions.

The OI Investment Thesis

Outstanding Investments has a straightforward investment thesis. We invest in energy and resource plays because over time — we believe — energy and resource investments will become more valuable. There are a number of reasons for this, including geological scarcity, past underinvestment and increasing future demand. But it’s a basic idea, and we think it works. At least, it has worked for the past six years or so.

For the past few years, OI has been selecting investment ideas in companies that appear to have bright futures in a looming era of rising energy and resource demand. And many — most, really — of the investment ideas did well. Some did very well. A lot of readers made a lot of money. Whether it was oil, gold, refineries, cement or energy infrastructure, it seemed like we were investing in places where the world was going. Right?

But now it seems like the investment locomotive — energy, resources and related infrastructure — has derailed. Energy prices are declining. Energy-related stock plays are down. Commodities are down. Mining and infrastructure stocks are in the dumps. The falling tide is leaving us high and dry.

But does that mean that the whole OI investment thesis is unraveling? Not so fast, pilgrim. Let’s keep on thinking this through.

Until we meet again…
Byron W. King
October 17, 2007