As much as we’d like to believe we’re good predictors, the reality is we aren’t. Even the so-called “experts” tend to have a pretty crummy record when it comes to calling the big picture.
We all know folks who have been talking about inevitable interest rate hikes for years now. During each downward blip of 2014, our televisions were filled with pundits saying stocks would finally crash after an almost uninterrupted bull market since the depths of 2009. Even Canadian housing has been firmly in bubble territory for years now, chugging merrily along as observers worry more and more about a crash that never comes.
A more recent example of the fallibility of analysts is the recent decline in oil. I try to pay attention to what smart people are saying, and I didn’t hear one person warning against oil stocks during the summer months. Crude was expensive, profits were good, and the energy sector was firing on all cylinders. There was no reason to be bearish, thus nobody was.
Now that it seems like every market observer is predicting further energy weakness in 2015, I’m placing my bets on the opposite side of the ledger by buying oil. These companies are cheap, and I’m not about to believe the same folks who just got the decline in energy completely wrong.
I’m not completely discounting those who think energy could go even lower in 2015 though. Although several of the largest producers have cut their budgets for the new year, there are still plenty of other projects scheduled to come online. It remains to be seen whether production will decline enough to nullify the supply and demand imbalance currently plaguing the market.
This scenario has led investors in the sector to hedge their bets, so to speak. Instead of investing in companies that have been really beaten down, they’ve chosen to go for quality, investing in names like Suncor Energy Inc. (TSX: SU)(NYSE: SU) and Imperial Oil Ltd. (TSX: IMO)(NYSE: IMO).
On the surface, this seems like a prudent move. Both these companies have stellar balance sheets and plenty of low-cost oil sands production. Billionaire investor Warren Buffett holds a large stake in Suncor, while Imperial Oil is majority owned by Exxon Mobil, the largest oil company in the world. With backing like that, it’s obvious that neither company is going bankrupt.
The problem with the flight to safety is most other investors have had the same idea. Imperial Oil’s shares are still up in 2014, while Suncor is in positive territory if you include the company’s dividend. Considering the decline in the price of crude, that performance is nothing short of remarkable.
But investing in the strongest names in the sector also limits upside when it inevitably recovers. The iShares S&P TSX Capped Energy Index Fund (TSX: XEG) is down nearly 20% for 2014 and has fallen more than 34% since oil peaked in the middle of June. A rally in crude should cause many of the weaker names in the sector to surge, as the market stops thinking of them as bankruptcy candidates.
If crude remains low or goes lower, the high quality names will continue to outperform. But if you think that’s the case, why own the sector at all? It’s better to sit on your cash for a few more months and buy when things are really depressed. Or, you could cycle into sectors that do well while crude is depressed, like the airlines.
I’m a long-term oil bull, which is why I’m buying energy. I just think there are smarter ways to go about it than buying Suncor and Imperial Oil. They’re great companies that just aren’t cheap enough for me. The time to buy them is when investors get so pessimistic about energy that even the best of the sector start getting creamed. I’m not sure we get there, which is why I’m buying other energy companies now. I suggest you do the same, and look at others in the sector, but maybe keep a few bucks in cash just in case either company gets really cheap.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.
Fool contributor Nelson Smith has no position in any stocks mentioned.