We have a special way of looking at stocks and ETFs
If you have seen this explanation before, please jump to the next bold-faced headline.
Technology advances in communications and information have transformed the way securities markets operate, and the way major investors behave as a result. Prices of equities now normally gyrate during one-year elapsed periods in ranges that are typically multiples of the underlier's trend growth.
Which means that during part of the year period their prices are retreating, and are consuming investments of time which cause the "growth" trend rates to be far less than what their better progress periods provide.
Advances in information technology encourage investment professionals (the market-making [MM] community) to protect the capital they must put at risk to do their jobs. Those actions cause the markets for equities and derivatives to become more integrated than they were in much of the 20th century.
So we study what the Pros' behavior causes to happen in the price-change "insurance" derivatives markets, to understand just how far it is reasonable to believe specific stock and ETF prices may move, both up and down, in the next few months.
This analysis has been conducted without material change daily for over a decade on more than 2500 widely-held and actively-traded stocks and ETFs. The resulting price range forecasts provide an actuarial history (unmatched elsewhere in the investment community) of subsequent market prices, as testimony to the strength or weakness of the forecasts made earlier.
Near-term price gains are most important to investors who are now either starting out in building a portfolio's wealth and exploring how it may best be done, or to investors who have come to realize that plans made years earlier are unlikely to be met at current rates of investment wealth accumulation.
Active investing, where capital is constantly put to work in the best odds-on situations to deliver profit within foreseeable time horizons, is the strategy most likely to produce what is needed, at least risk. But active investing needs guidance as to what to do, when to do it, and with what intensity.
Active Investing in Integrated Oil Major Stocks
Integrated Oil Major Company stocks at this time are interesting vehicles for Active Investing as a strategy for several reasons. OPEC is coming back into a potential positive influence on crude oil prices. The price of crude is a major determinant of activity and profits for the whole world energy industry, including oilpatch servicers, refiners, transporters, and distributors.
Overlaid on the international supply contests is a groundbreaking (pun intended) change in resource extraction technology. Begun and under major development in the US for over a decade, the supporting geological conditions involved are prevalent worldwide. It has enormously expanded the presence of energy source fuel reserves, especially here in North America.
But competitive costs of production depend on well-development techniques learned mainly by on-the-spot experience. That keeps the technology impact importantly concentrated in North America, the world's largest energy consumer, since many conventional-production supply sources (most notably national companies) work from extensive established low-cost reserves.
Still, the world's oil prices are importantly impacted by the technologies of fracking and horizontal drilling that are becoming price-determinants here. That is because the US has become a major importer of crude oil, and is now in the process of becoming energy-independent in world trade. Along that path, US exports of energy fuels, initially natural gas, will become a limiting influence on world prices.
Now crude is priced, worldwide, on two basing points, WTI (West Texas Intermediate) and Brent (North Sea, Europe) with principal exchange markets in New York, Chicago, and London. Modern-day electronic communications instantly weave their inter-relationships into availability worldwide. Local adjustments are made reflecting the cost of transport from supply source to points of consumption, an often not-trivial consideration.
Particularly in the US the proximity of major energy consumers to the new supply sources makes transportation costs a further impetus to the national energy independence shift. Pipeline transit can be considerably cheaper and more reliable than (sometimes) weather-influenced or international-conflict-impeded ocean shipping.
The energy-independence issue is further an issue in the yet-to-be-calamitous resolution of national currency acceptance, one being created by governmental central banking interferences in interest-rate markets. Ultimately, Gresham's Law of bad money driving out good will cause a concentration of world capital into the currency most able to be the best survivor.
A strengthening world-trade balance by the USA is likely to make the US Dollar that survivor, and the collapse of other world currencies ultimately is likely to educate policy-makers in the necessity of market-enforced rational capital-cost pricing (interest rates).
But back to oil pricing.
There is another economic complication overlay to crude oil pricing, that of the principal demand for the refined product of crude, gasoline, now in the early stages of being influenced by changing consumer desires. Desires (first) for more economic costs of ground transportation, and (secondly) by a desire for more ecologically-satisfying means of preserving the atmosphere. A desire while achieving the necessity for personal availability of transport reasoned by "my time and convenience is more important than just money."
The ecology question takes the form of electrically-powered automobiles. Clearly the auto industry senses the developing consumer demand, and is enlisting marketing accomplices to hasten the conversion.
The economics do not favor the presently-organized energy industry of North America, which delivers gasoline as its principal profit product. The product is refined from crude to deliver heat energy to internal combustion engines (ICE) providing torque traction to vehicles located variably all over the continent.
Crude, the fuel for that torque traction has a BTU content cost that at $50 per barrel is multiples of the heat content of Natural Gas at $3 per million BTUs (both compared at exchange prices). NatGas is in the process of driving the electric utility industry out of the use of coal as a fuel, which cannot compete with BTU costs under $4, given ecological requirements. The presence of that less-desirable, higher cost fuel keeps a lid on the ultimate price for NatGas.
The utility industry has the delivery system in place to provide electricity everywhere in the continent. Electric motors provide the torque traction much more efficiently (in terms of BTUs) than ICEs, and the delivery cost of both the kilowatts and the pipelined NatGas fuel to the demand points is less than the refining and delivery costs of gasoline.
On top of that, the power to control pricing by the old "seven-sisters" industry establishment of integrated energy companies is severely undermined by a flood of new competitively-capable oil and NatGas producers adroitly using the new extractive technologies.
Those competitors are further aided by the advantageous geographic location of very extensive, favorable-cost reserves of NatGas relatively close to major population centers of transportation-hungry consumers.
No matter how much OPEC or other producers might like to see Brent crude prices over $50, it appears that may be an impossible dream, near-term or long-term. US exports of NatGas are just beginning, and the infrastructure to greatly expand them is already well under development. Oil exports are likely to follow, as imports decline and disappear (except as supply for refined product exports).
Interim setbacks and failures keep opportunity valuations in flux among many enterprises. Physical development times and marketing efforts under government regulations and peer review progress vary across international boundaries. Competitive pressures from new organizations' blossoming successes can impact established firms.
Imperfect understanding of the underlying economics by investors, goaded by opportunistic enthusiasm, can create excessive stock price evaluations. Or may lead to undue interim discouragement.
Figure 1 looks at the market activity and dimensions of the Integrated Oil stocks, all of which pass our screens of comparability and attractiveness to institutional investors. There are two dozen of them, and are ranked simply by market capitalization size. Those sizes range from $100 billion to a small fraction of $1 Billion.
Source: Yahoo Finance
Some perspective on this data lies at the bottom of the table. There averages of the more significant columns are compared with their largest and smallest components, and with the same dimensions of the market average NYSEARCA (NYSEARCA:SPY).
Many of these stocks are fairly illiquid, given their size, when looked at from a capital investment turnover point of view. The average Integrated Oil stock takes over ten years to trade its entire stock capitalization; the extremes approach infinity among some of the international majors, many of which have controlling national government ownership. In contrast, the market proxy ETF, SPY turns over its $200 billion market cap in two weeks, $20 billion a day.
The market activity is strong enough to make transaction trade spreads of little concern, with only a couple of exceptions, particularly in after-hours trading.
Now the opportune part of the table is the typical volatility of prices in the group over the course of the last year: Highs of 96% above the lows, on average. Street analysts have average annual earnings growth in the next 5 years all over the map. Their 1-year price change estimates average -3%, suggesting very full current pricing for the group.
With that kind of volatility, where are they priced now? The average past-year Range Index (calculated the same way as a future forecast Range Index, but looking back in time, not forward) is 79. That means the group on average is priced four-fifths of the way up a zero-to-100 indexed range. There is four times as much downside price potential going back to the bottom as there is upside, reverting back to the top.
The lowest-priced stock, Exxon Mobil Corporation (NYSE:XOM) is right at its prior year's mid-range point, up 42% from its low. All the others are in the top half of their 52-week ranges, with gains of ~75% from their lows.
One speculative marginal international producer has been a 3-bagger at best ($10,000 turning into $39,200), and others - including the industry leader - at worst gained just 34% ($10,000 turning into $13,400). These have been considerably more profitable, YTD, than SPY, where a New-Year's $10,000 has only grown to $10,700 now after reaching an interim $12,100.
But so much for history, what is yet to come? The street (sell-side) investment analysts offer 1-year price targets for many of these stocks directly, and others are imputed from current P/Es and estimated 1-year EPS collected by Yahoo Finance. On average these targets are below present prices by -3%. Average P/Es now are a myth, with losses per share being the rule, partly explaining the depressed stock price lows.
But street estimates for the future are tinged with employer conflicts of interest, a condition unfortunately displayed many times in the past.
We find a much more reliable set of future price estimates coming from the same employers as they act in a different, but essential role. That role is as negotiators for big-money investment funds attempting to adjust the holdings in their portfolios.
Due to the clients' typical $-billion portfolio sizes, multi-$ million trades would flash-crash the automated transaction system of "regular-way" trades. So such "block trades" must be negotiated between clients issuing desired trade orders and with other prospective big-money investment funds to be on the other side of the trade.
It is rare to be able to "cross" the desired volume of shares at the limit price specified by the trade-originating client, so the market-maker [MM] may become a principal in the trade temporarily, picking up a long or short "stub end" of the block. But that is done only when an acceptable hedging deal can be arranged to protect the MM's capital put at market risk.
The cost of that price insurance is borne by the trade-originating client, so it must not be so large as to kill the trade. So the terms of the hedge, which define the outer limits of near-future prices of the subject stock in the block trade order, are a consensus of all three parties, the trade originator, the MM, and the seller(s) of the other side of the hedge.
It turns out that the sellers of the price protection hedge are often the proprietary trade desks of other MM firms, who are as equally well-informed as the MM firm negotiating the block trade.
Thus we have specific, honest unbiased forecasts of future price limits, both up and down, motivated by the self-serving competing interests of the participants in an open-market negotiation.
Those limits can help define prospective investment reward and risk on an issue-by-issue basis that is directly comparable between alternatives, regardless of their underlying competitive or economic circumstances. Those essential minutiae have been subsumed in the hedging negotiations.
Figure 2 uses those forecasts in making comparisons of price Risk vs. Reward tradeoffs between alternative investments.
(used with permission)
Each stock or ETF is positioned in this map by its intersection of upside price change forecast on the green horizontal scale and experienced price drawdown exposures (on the red vertical scale) typical after prior forecasts like today's. Any issue above the dotted diagonal has more potential risk than return at its present price.
A market-reference by SPY would be to the right of  and below . Notably, none of the Integrated Oil stocks has less downside risk than SPY. but most of them have higher reward prospects along with their greater price drawdown exposures.
The most opportune on a reward-to-risk basis are ConocoPhillips (NYSE:COP) at  and Hess Corp. (NYSE:HES) at . But nowhere in sight here are the kinds of attractive tradeoffs seen in many other maps of this type where securities approach or enter the appealing green area of 5 to 1 or better tradeoff ratios.
Since price-change risk is a dynamic, not a constant, in time these exposure relationships will change. It is these changes that provide fresh opportunities for active investment capital gains on a shorter-term recurring basis. Besides just the downside price exposure, there may be other investment attributes investors will want to consider. Figure 3 provides some of these.
Columns (5) and (6) are the source for Figure 2 coordinates. The (7) metric tells what % of the (2) to (3) range lies below (4). It discriminates among (12) prior forecasts to select the similar sample from which columns (8) to (14) data is provided. (13) compares (5)'s promise to (9)'s prior delivery; (14) compares (5) to (6). (15) is a figure of merit combining the several qualitative measures into an odds-weighted, risk-conditioned number.
For this exercise we ranked the top equity interests by the (15) figure of merit. At the bottom of the table, in blue, we have averages for the 20 Integrated Oil stocks, along with a forecast population of 2600 stocks and ETFs, including an average of the currently best-ranked 20 issues from that population. The current parallel statistics for market-average SPY are also present.
It is highly unusual to see 21 stocks with a combined market capitalization of nearly $2 trillion be such a poor place to attempt wealth-building during the next 3 months. Essentially, this huge amount of investment capital is aimlessly adrift. Market professionals apparently find very little appetite for this segment of the energy industry coming from their big-money portfolio management clients.
The present level of market activity in these stocks and their enormous size creates an average capital turnover rate of more than ten years. To change that would require a drastic shift in the expectations of the major investor (institutional) community. That is most likely to depend on a widespread conviction that crude oil prices will revert to near doubles of their current $45-$50 level.
A long-term supply-demand shift supporting such a price move is hard to see without the sudden and lasting removal from availability of an existing large source of supply. The present geographic diversity of world supply sources and the advances of extraction technology impacts on resource availability and cost reduction of production make the likelihood of any such supply reduction's lasting quite dubious.
We regard the 20 Best-Odds Forecasts from the population of 2600 forecast-able equity securities as the competition in any capital commitment contest to improve a portfolio's prospects. Since Figure 3 is ranked by (15), the average of the 20 Best of (15) at 40.2 is a bogey of sorts. If half of the 20 Best (15) of 20.1 might be a lower limit, none of the Integrated Oil stocks in Figure 3 is worth potential consideration as a capital commitment candidate. To make the comparison clearer, the best-ranked of the group, Chevron Corporation (NYSE:CVX), is the only one in the set that has an odds-on positive return, net of likely loss experiences. Statoil (NYSE:STO), the Norwegian state oil company, is currently at so low a Range Index that there is no history to evaluate. It may be an exception.
The odds of Integrated Oils in purchases at present prices, recovering from the group's likely average worst price drawdown of -8.6%, is an average of only 58 out of 100, little better than a coin-flip.
And the prospect of a return with a CAGR of +3% is laughable in comparison with an alternative of the average achieved CAGR returns of the population's best 20.
The appeal of the Top 20 is in their achieved +11.2% gains in periods following prior price range forecasts like those of today's. Their doing it in average holding periods of 42 market days, or two months, provides the opportunity to compound such results 6 times in a year, for a CAGR of +90%.
We every day examine and rank over 2,500 stocks and ETFs to find the most promising 20. No guarantees, but so far in 2016 some 2,866 of these daily Top 20s have shown position closeouts at a CAGR rate of +33.0%, while SPY as a buy and hold has logged only +7.2%.
The current best 20 offer average upsides of +10.8%, with actual prior gains in the same stocks averaging +11.2% net gains under the standard TERMD discipline following 4,200 prior forecasts just like those of today. Winning positions in those forecast experiences were 83 out of every 100, and worst-case price drawdowns on all 4,200 averaged only -7.6%. Those drawdowns were recovered from in every one of each win position in the 83 average, and then went on further to produce gains sufficient to offset the losses in the 17 out of 100, to reach that net of +11.2%.
And they did it in 42 market days, that's 2 months, so the results if repeated sequentially 6 times in a year could produce a CAGR of +90%. These best of the forecast population are what we regard as the competition, against which other investment candidates should be compared.
Additional disclosure: Peter Way and generations of the Way Family are long-term providers of perspective information (earlier) helping professional and [now] individual investors discriminate between wealth-building opportunities in individual stocks and ETFs. We do not manage money for others outside of the family but do provide pro bono consulting for a limited number of not-for-profit organizations.
We firmly believe investors need to maintain skin in their game by actively initiating commitment choices of capital and time investments in their personal portfolios. So our information presents for their guidance what the arguably best-informed professional investors, revealed through their own self-protective hedging actions, believe is most likely to happen to the prices of specific issues in coming weeks and months. Evidences of how such prior forecasts have worked out are routinely provided. Our website, blockdesk.com has further information.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.