Similarly, we may snicker now that many of us are sitting in heavy snow and ice, but it wasn’t too long ago that we were concerned that Russia’s drought, its subsequent effect on their wheat crops and in turn, the country’s ban on wheat exports would drive agricultural commodity prices sky-high. For some time, investors have been focused on the impact that higher commodity input prices, especially agricultural commodities, might have on food company margins. I noted this in an article on Consumer Staple stocks several months ago and it is likely to continue to be a factor for such names as Campbell Soup (CPB), General Mills (GIS) and Sysco (SYY).
Last Friday, when events in Egypt appeared to be intensifying aggressively, oil shot up over 4%. For many investors, the alternatives available in order to take positions in oil include ETFs such as (USO) or (XLE), the former meant to be a more direct play on oil, and the latter filled with oil related companies such as Chevron (CVX) and Exxon (XOM). There’s also OIH, the oil drillers/servicer ETF, though many of those companies are in XLE too. Or, investors might just own the respective individual companies embedded in these ETFs.
In the answer, lies the lesson learned. XLE’s constituent companies were encumbered by earnings announcements and by fears of production disruptions in some of their Egyptian facilities. Chevron, too, in its earnings announcement noted that its ‘proven reserves’ only covered 24% of 2010 production, a relatively low number which basically means that the company was selling more oil than it was finding or ‘reserving’ in the ground. In layman’s terms, that essentially means that unless they find new oil sources, then over the long term, they’re running out of product!
So based on what we’ve said so far, one might conclude that USO is the way to ‘play’ oil. But not so fast! Let’s not throw XLE and OIH (and their constituent companies) under the bus just yet. Another lesson learned, and again, often cited here, is that oil drillers are likely to see healthy demand for their services for some time to come…both to meet growing demand for energy around the world and to replace older proven reserves and wells that might be ‘drying up’. This has added to the general ‘higher oil’ view that is embedded in XLE and OIH names and has led to XLE and OIH actually outperforming USO in January.
Finally, January provided some lessons on global markets where Emerging Markets countries continue to emerge on the world stage in meaningful and new ways. Take the situation in the Eurozone where market participants are chronically living in fear of the next shoe to drop, the next country to face liquidity challenges, the next bond auction that runs the risk of meeting inadequate demand. Countries like Japan and China appear to be parachuting in to ‘save the day’ by declaring interest in buying European bonds and in promoting more business between their countries and Europe. This helped support the Euro through the month.
But Europe’s problems are far from over. The UK faces higher inflation and almost certainly slower growth in the face of severe austerity measures taken by the Government. On the Continent, a similar situation is occurring, but for those countries in the Euro, they lack the independent currency adjustment that could help support the economy as they too face august austerity measures.
So January’s relative calm in the Eurozone might mask the underlying structural fiscal issues that still exist. While I’m not ringing the alarm bells at this time, I am cautioning to keep Europe very much in focus.
Furthermore, Emerging Markets were the punching bag of many in the financial press who argued that the so-called bull run of Emerging Markets is over. Just a couple of weeks ago, I wrote an article on this very issue and I noted:
So are emerging markets deserving of a bad rap? Is the so-called “bull-run” (at least of the past 2 years) over? Are the fates of these countries glued to what happens to oil, copper, soybeans, coffee and the like? Or are they positioning themselves, or dare I say, “emerging” into less vulnerable, more diversified economic entities?
One right answer is certainly, “time will tell”….but the more appropriate answer, at least for some of these countries, is that for every day that the commodity ‘windfall’ continues, they are one day further away from being ‘one horse wonders’ and one day closer to more fully emerging. In that sense, you might say, time is on their side. This dynamic argues for ongoing close scrutiny of these equity markets, and a view as to when the price is right for buying (or adding).
For now, the inflation fight is likely to keep upside somewhat limited for most of these markets. But after assessing the historical perspective cited above along with the individual country dynamics towards diversified growth, investors are likely to find some investment opportunities, nonetheless, especially in locally driven businesses. You might say that what is currently getting a ‘bad rap’ might actually turn out to unwrap some pretty good things down the road.
In sum, January certainly got the year off to an interesting start, offering up lessons that should stay with us in coming months. I’m not a big fan of spending too much time in the rearview mirror, but to ignore meaningful historical events would be to exclude key elements in one’s investment assessments. And whether you ‘warm’ to the ideas noted herein or not, at least consider normalizing ‘weird’ events into their likely impact on investment choices. That might just keep your portfolio ‘hot’, and not ‘flat and crowded’!
(Please note: This article is solely meant to be thought provoking and is not in any way meant to be personal investment advice. Each investor is obligated to opine and decide for themselves the appropriateness of anything said in this article to their unique financial profile, risk tolerances and portfolio goals).
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Additional disclosure: Long many stocks within SPX, OIH, XLP and VWO. Positions may change at any time without notice.