Mental-Distancing Investing For The New Economic Paradigm
Summary
- A new and different investment paradigm is upon us as the pandemic alters business as usual.
- Economic recovery is being pushed out further into future time horizons, according to various analyses.
- The rebalancing of oil markets won’t likely occur until later in 2021 or 2022.
- The idea of increasing interdependence is going to play out within countries and between countries.
- My new approach is to sort of mental-distance from former investing habits.
From the recent data and analysis occurring across multiple sources, the economic environment in which we find ourselves is looking tepid, to understate things. Dallas Federal Reserve Bank President Steven Kaplan stated in a Reuters interview that he does not expect the global oil glut to be absorbed until some time in the second half of 2021, even into 2022 if economic recovery is weaker than expected. He further expects that U.S. oil and gas producers will reduce output to 10.8 million barrels a day by year end, roughly about 2 million barrels per day below last year’s level. Producers have cut capital expenditures by one third. Oil markets have generally been a factor that I consider when assessing how economics and geopolitics are changing.
Oil demand and supply are in a state of rebalancing in the near term and the longer term. OPEC+ agreed in April to cut output by 9.7 million barrels per day (b/d). The pact will be discussing the easing of curbs to 8 million b/d between July and year-end. However, the Saudis wish the 9.7 million to be maintained. Russia, pacified by $40 oil, wants to ease curbs by July. Russia believes that demand is recovering faster in China, Europe and the U.S. The Saudis need an oil price closer to $84 to match their spending levels.
The two major world producers will probably meet in the middle both in timing and cuts, notes the Wall Street Journal article. According to Oil and Gas 360: “OPEC and its allies agreed in April to cut output by 9.7 million bpd, with 6.084 million bpd to come from OPEC members. In May, they cut 4.48 million bpd, Reuters reported–74% compliance with agreed upon cuts.” A compliance factor typically exists with the production agreements.
Economic Impacts of COVID-19
Researchers at the Dallas and New York Fed, with a Harvard econometrician, developed a Social Distancing Index (SDI). The index, coupled with economic activity, shows how social distancing behavior has reduced economic activity.
The Fed notes:
In the second half of April, social distancing began to recede, while the Weekly Economic Index (WEI) only slowed its decline. While it is too early tell, a continued drop in the WEI could indicate more conventional recessionary dynamics, as cautious consumers and businesses pull back from spending and hiring, amplifying the initial disruption caused by social distancing.
The chart on the right indicates that in “recent weeks signs of improvement are showing in small business activity as social distancing begins to wane,” the Fed notes.
Continuing in their assessment of the impact of COVID-19, the Fed analysts believe that social distancing will stay elevated as long as the threat of infection persists, regardless of official restrictions being lifted. With regrets, I echo that sentiment. Barring a vaccine or treatments, most people will remain cautious.
In Dallas, where social distancing has been slowly lifting, an obvious uptick in traffic is apparent. However, in addition to some level of business openings, one does not know exactly what that indicates. Is it more trips to stores and businesses vs. online ordering? Are people making more trips rather than combining them because they were locked down? Dallas also is seeing more COVID-19 cases with several weeks of opening and more testing.
Another major factor is the increasing numbers of unemployed workers. Aside from hard-hit travel and leisure industries, the oil patch is shedding staff. Halliburton (HAL) says they will cut 22% of headquarters staff, plus those already cut in operations. Chevron (CVX) will cut 15% of its global workforce. Energy Transfer (ET) will cut 6% of its workforce. Unemployed people will not be spending beyond the essentials.
The U.S.’s consumer-led economy isn’t consuming like before. The Congressional Budget Office noted that the U.S. economy would require this decade, ie., many years, to return to the pre-pandemic economy. On the global front, the same story repeats itself with China’s recovery stalling, given that export orders are being reduced. Also a sign of the times, India and South Korea, two engines of growth in the past, report reductions to payroll.
Even new measures of what “growth” is may emerge. For example, environmental and social factors may be considered more when assessing the financial situation of firms. The Sustainability Accounting Standards Board (SASB) launched its 77 industry-specific reporting standards, with 120 companies now using the standards in their ESG reporting, according to an article dated December 2019. In late 2019, 49 investors representing $34 trillion in assets were participating in the SASB’s investor advisory group. GM (GM), Merck (MRK), Nike (NKE) and JetBlue (JBLU) were early adopters of SASB guidelines. Doing more with less, or differently, may take many new forms as we have seen during the pandemic.
Interdependence
The idea of increasing interdependence is going to play out within countries and between countries. We cannot recover and progress without cooperation. The Walmarts (WMT), Amazons (AMZN), and Microsofts (MSFT) know how to adapt and develop partnerships. This concept is wider ranging and farther reaching than it implies. If a virus and its aftermath creates the systems’ destruction that COVID-19 has, the implications for investing and larger problems facing the global commons like climate change is huge. Where will the monies flow to? To what end? How will social forces shape a changing economy? Social distancing, coupled with protests about social injustice, are a potent combination as we've witnessed.
In the energy space, I expect more mergers and acquisitions, especially as bankruptcies rise. The majors, such as Exxon Mobil (XOM) and Chevron (CVX), will likely begin buying up oil and gas assets when more pain sets in. British Petroleum (BP) and Shell (RDS.A) (RDS.B) are staying committed to pursuing plans toward more low-carbon energy opportunities, both internally and externally. BP plans to increase its investment in non-oil and gas businesses, roughly $500 million per year or 3% of overall capital expenditures. Obviously, oil and gas are in the energy mix for many decades. But the question is: How does one invest in this new era of transitions on multiple fronts?
Many oil and gas firms are positioning to ride out the storm through capital expenditure reductions, dividend cuts, and layoffs. Oil prices will eventually rise some once the excess capacity declines, as it will over the next year. The U.S. Energy Information Administration expects WTI and Brent pricing to rise to the mid- and upper 40s in 2021. I’m not so sure that global demand will be back to nearly 100 million b/d in 2021 as projected. Yet, independents EOG Resources (EOG) and Parsley Energy (PE) are now upping production to leverage opportunities from the declines in capital spending and higher expected declines of shale wells later in the year.
Returning to the theme of energy transition, my stock choices will increasingly reflect those firms that manage themselves for sustainability. Business-as-usual thinking will not be an attractive corporate philosophy for asset allocation. The new normal has only just begun, with undefined contours. Hannon Armstrong Sustainable Infrastructure Capital (HASI), the financier of sustainable infrastructure, is one such stock I have been happy to own before and during this pandemic. Firms that use resources well are an attractive fit for my evolving and developing criteria, along with some flight-to-safety firms that will adjust and find opportunities.
A new and different investment paradigm is upon us. Entire sectors of the global economy have been shaken up dramatically with many downstream consequences and ripple effects. I’m taking a very cautious, open-minded and deliberate approach to re-assessing my next steps in investing — a sort of mental-distancing of former investing habits.
This article was written by
Analyst’s Disclosure: I am/we are long HASI. 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.
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Comments (25)
Just sayin'.
Thanks for another interesting article! For some very interesting and different times!
