Behavioural finance analyst Ken Norquay observes that investors love to read the financial news and study its impact on stock prices. But what should be more relevant for investors and their strategic investment objectives—long-term financial trends—doesn’t always make the daily news cycle.
In the financial world, people get addicted to the news. Most believe that the ups and downs of daily market activity are caused by financial news. But conservative investors claim not to be interested in the daily fluctuations of the market. They are interested in the long-term financial trend. They like to own securities in up trends and have someone else own the securities that are in down trends. Fluctuations are mostly irrelevant.
So why do some investors find financial news so intoxicating? Although short-term news keeps us amused, it can distract us from more important investment factors. What is relevant for us is change in long-term financial trends. The financial media never reports that.
In the long term . . .
A few weeks ago, OPEC (Organization of Petroleum Exporting Countries) announced production cutbacks. These cutbacks could affect the balance between demand and supply of oil. In my investment book, Beyond the Bull, I explain in detail how changes in supply or demand affect price: in the stock market, changes in supply and demand are the root cause of price changes. OPEC production cuts lower the supply of oil to the market: this tends to push price of oil up. Did it work? Have oil prices risen?
Obviously not. There hasn’t been enough time for the supply of oil to be affected. It will take weeks, maybe months, for the cutbacks to be felt. Their well-staged news release was more signal than substance. It showed that after years of being ineffective, OPEC was finally able to cooperate, at least in a small way.
What are the factors that will affect the price of oil in a big way? The oil business is important to Canada, to our economy, our currency and our personal retirement savings. Let’s examine what really determines the long-term supply and demand for oil. What really determines oil’s price over the long term?
Supply and demand for oil
‘Demand’: Oil is used by cars, electrical generation companies, farms, aircraft, for heating buildings, etc. These factors are common knowledge, as are the factors that influence them– weather, the overall health of the economy, etc. None of this is noteworthy, because it is all common knowledge.
The same could be said for ‘Supply’. Oil companies produce oil at some price, and hope to sell it at a higher price. Saudi Arabia produces oil for about $10 to $28 US per barrel. Canadian tar sands produce oil for $55 to $95 a barrel. Not all oil is equal: Saudi oil is very high quality; tar sands oil is very low quality. Saudi Arabia holds the largest reserves of oil in the world; Canada, the second largest.
If oil prices rise substantially, Canadian tar sands oil will be profitable again, and the supply of oil to the world will be increased by additional Canadian production. At lower prices, the tar sands are unprofitable and supply decreases. These factors are widely known and hundreds of experts follow them every day. Every oil company and every major investment firm have experts who follow the supply and demand for oil. Price is determined solely by supply and demand.
Up or down?
It is not important that we outsmart all these experts. Let’s just ‘stick to our knitting’. Let’s do what we can do, and leave the detailed studies to those who think they can outsmart the market. For our part, we need to know if the price is going up or going down. If it’s going up, we want to invest in it. If it’s going down, we don’t.
In June of 2014, the price of oil (over $100 US per barrel) began a down trend that lasted until February of this year, to under $30 US per barrel. The price bounded up to about $50 in June and has zigzagged slightly lower since. Our study of price trends tells us that often, after a major decline in price (oil’s 70%+ decline was a major decline!), we should expect a bounce up followed by another decline to the vicinity of the previous low.
In this case, we saw a bounce from under $30 to about $50. We should expect to see a decline to about $25 or $30 again. If that occurs, we could consider investing in the energy sector again. This price trend pattern is called ‘testing the lows’. If the post rally decline holds above or near the previous low price, the ‘test’ is considered a success, and the trend has reversed from down to up.
The legendary New York Yankees catcher, Yogi Berra, once said: “It ain’t over ’til it’s over.” The down trend of oil prices? It ain’t over yet. Wait for ‘the test’. However, there is a possibility that ‘the test’ has already occurred. From its high (just over $50) in June, oil dropped to just under $40 in early August. Since then it has moved back up to the high 40s.
While it is unlikely that this was ‘the test’, it IS possible. We recognize the possibility that the down trend of oil prices ended in February of 2016. If this is true, oil’s price should hold above $40 and rise to over $50 in the next few months.
As for the market . . .
Although oil prices got most of the media’s attention, the more interesting news occurred in the stock market. In the month of September, volatility increased sharply. Volatility refers to the range of price change in a fixed time period. For example, all summer, the S&P 500 Index traded in a 10 – 20 point daily range. In September, that number doubled. Higher stock market volatility means the participants in the market are more emotional than on days of low volatility. In September, traders and investors were more emotional than in July and August.
But in spite of that added emotion, there was no trend change. The U.S. stock market is still going sideways following a multi-year up trend (2009 to 2014). Our advice remains unchanged: use this sideways period to reduce your exposure to the stock market. There is a strong possibility that an important down trend will emerge from this 22-month sideways US market.
In my last MoneyLetter article, I outlined a bullish scenario for the U.S. stock market. Maybe my bearish outlook is incorrect. Maybe the market will emerge from 22-months of non-progress into an up trend. My bullish scenario was:
■ The market would increase by about 10% above the previous high.
■ It would decline, giving back approximately what it had just gained, then
■ It would continue up.
A watered down form of this bullish scenario did occur. In late August there was a mini pop up to a new high in the S&P 500, and within the volatile trading of early September, a sharp drop did occur. Although the actual percentage was less that the 10 per cent in my theoretical bullish scenario, the emotionality (volatility) was there. I will keep you informed about this bullish possibility. Maybe one of America’s two presidential candidates really can prevent the decline that the stock market is foretelling. If the long term up trend does reassert itself, we will want to throw caution to the wind and reinvest in American stocks.
Precious metals: The price of gold changed from a down trend to an up trend in December 2015. Investors can continue to increase their exposure to gold and silver. Gold and silver mining stocks continue to provide opportunity for experienced traders. Caution: many gold mining stocks have doubled or tripled since I first recommended them as trading vehicles. Please review your trading rules now, especially your exit strategy.
The Canadian dollar down trend is still intact, although the day-to-day changes are miniscule. Those who invest in non-Canadian markets may receive some benefit from this continuing down trend. Please review earlier comments on the price of oil. The Canadian dollar is a petro-currency and will trend with the price of oil.
The U.S. dollar index has been in a trendless sideways range since spring of 2015. This stability helps the world’s banking system, but doesn’t leave much opportunity for profit in our personal investing.
2016 has been The Year of Big News. The United Kingdom voted itself out of the European community, the Arab nations are once again trying to fix the price of oil, and soon our American friends will elect a new president. In the long term, will any of this make a difference to your personal investing?
Ken Norquay, CMT, is the author of the book Beyond the Bull, which discusses the impact of your personality on your long-term investments: behavioural finance. He can be reached at firstname.lastname@example.org.
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The MoneyLetter •10/26/16 •