- Exxon Mobil was removed from the Dow Jones Industrial Average on Monday, Aug. 31, 2020.
- Salesforce.com replaced Exxon Mobil in the DJIA.
- Since that date, Exxon Mobil has vastly outperformed Salesforce.com, with XOM shares rising 56.3%, and CRM shares declining 24.6%.
- This performance is reflective of a broader market shift where economically-sensitive and inflationary assets are outperforming the disinflationary performance leaders of the past decade.
- Many market participants have very little exposure to energy equities, as it's a very small part of the S&P 500 Index. This fact is adding to the relative performance pendulum swings.
- This idea was discussed in more depth with members of my private investing community, The Contrarian. Learn More »
If everybody indexed, the only word you could use is chaos, catastrophe… The markets would fail. - John Bogle, May 2017
A 60:40 allocation to passive long-only equities and bonds has been a great proposition for the last 35 years… We are profoundly worried that this could be a risky allocation over the next 10. - Sanford C. Bernstein & Company Analysts (January 2017)
Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria. - Sir John Templeton
On Aug. 28, 2020, I wrote one of my favorite articles of the past several years, titled, "Exxon Mobil Exit From Dow Reveals S&P 500 Index Structural Flaws."
In the article, I described the background of S&P Global (SPGI) making the decision to remove Exxon Mobil (NYSE:XOM), the oldest member of the Dow Jones Industrial Average (DIA), from the index effective Aug. 31, 2020, and replacing XOM in the venerable index with Salesforce.com (CRM).
Part of the rationale for why S&P Global was removing Exxon on that specific date, meaning Aug. 31, 2020, was related to the Apple (AAPL) 4-1 stock split, that was effective the same day. This caught my eye, as I had flagged Apple shares as historically expensive earlier in August of 2020.
Ultimately effective Monday, Aug. 31, 2020, S&P Global added Salesfore.com to the DJIA, alongside Amgen (AMGN), and Honeywell International (HON), while removing Exxon Mobil, Pfizer (PFE), and Raytheon Technologies (RTX).
(Source: S&P Global)
While most investors applauded the removal of stodgy, seemingly non-ESG compliant Exxon Mobil from the Dow Jones Industrial Average, and cheered the addition of new economy stalwart Salesforce.com, Exxon Mobil shares have risen 56.3% since that infamous date, and Salesforce.com shares have fallen 24.6%.
Bigger picture, this relative and absolute outperformance of the old industrial giant compared to the new economy star is reflective of a shift in market performance that has been ongoing since the broader market lows in the S&P 500 Index (SP500) on March 23, 2020. Up until recently, the overall positive performance of the broader market indices partially masked what was going on below the surface of the indices, however, recent downside volatility in the hottest sectors of the market, including the former red-hot SPAC sector, where Churchill Capital Corp IV (CCIV) has given up more than 50% of its value in less than a month, has brought this price action to the forefront of investors' attention.
Exxon Mobil Has Outperformed Salesforce.com Since Its Removal From the DJIA
Effective Aug. 31, 2020, Exxon Mobil shares were removed from Dow Jones Industrial Average and were replaced in the index by Salesforce.com shares. Since that date, Exxon Mobil shares have vastly outperformed Salesforce.com shares as well as the SPDR S&P 500 ETF (SPY), which is illustrated in the chart below.
(Source: Author, StockCharts.com)
The performance chart above is from intra-day Friday, March 5, 2021, so the actual performance will fluctuate with market prices. Having said that, the sheer magnitude of the outperformance of Exxon Mobil shares over Salesforce.com shares since the removal of Exxon, and the addition of Salesforce.com, to the Dow Jones Industrial Average is eye opening.
Simply put, an investor who purchased shares of Exxon Mobil on that date is up 56.3%, while a comparable investor who purchased shares of Salesforce.com is down 24.6%.
When I wrote the article, "Exxon Mobil Exit From Dow Reveals S&P 500 Index Structural Flaws," on Aug. 28, 2020, I used the following two valuation tables from Morningstar to show how undervalued XOM shares were compared to their own historic barometers (the first table below), and how overvalued CRM shares were compared to their own historic barometers (the second table below).
(Source: XOM Valuation Table From Author's August 28th Article)
(Source: CRM Valuation Table From Author's August 28th Article)
With the benefit of hindsight, clearly valuation still mattered, and paying 110 times earnings, or 105 times EV/EBITDA, which was the case for CRM's valuation ratios upon entry in the Dow Jones Industrial Average, was an expensive learning lesson for those who arbitrarily picked the index constituents of the Dow Jones Industrial Average.
Economically Sensitive Assets Are Outperforming Led By Energy Equities
Over the past year, I have used the following performance graphic, which shows the performance of economically sensitive and inflationary sensitive assets compared to broader market barometers since the equity market lows on March 23, 2020.
Looking at the chart above, the SPDR S&P Oil & Gas Exploration & Production ETF (XOP) has risen 173.4% since March 23rd, 2020, the SPDR S&P Metals & Mining ETF (XME) has risen 154.3%, led by steel related names like U.S. Steel (X), which I profiled here, and the Energy Select Sector SPDR Fund (XLE), whose two largest holdings are Exxon Mobil and Chevron (CVX), has risen by 113.8%. All three of these sector funds have strongly outperformed the SPDR S&P 500 ETF and Invesco QQQ Trust (QQQ), which have risen 77.3%, and 65.9% respectively, as the performance chart above illustrates. The VanEck Vectors Gold Miners ETF (GDX), which led the recovery until November of 2020, has fallen behind in relative performance terms, yet it is still higher by 51.7% since the broader equity market bottom in the spring of 2020.
Many Investors Have Not Participated In The Historic Capital Rotation
In the recent article I published on Feb. 6, 2021, titled "Rates Are Rising, And It's Not All Roses For Investors," I highlighted how most of the SPDR S&P 500 ETF was composed of sectors and stocks that benefited from disinflation and deflation.
Building on this narrative, the energy weighting of the S&P 500 Index, had fallen below 2.5% early in 2021.
(Source: S&P Global Snapshot From February 6th, 2021)
In contrast, the technology sector. of the S&P 500 Index, as measured by the Technology Select Sector SPDR Fund (XLK), which is effectively the longest duration asset in the market, had increased to 27.8% as of this S&P Global snapshot, and this weighting was actually severely understated.
As I explained in the aforementioned article,
The answer is simple. Amazon (AMZN), which has a 4.3% index weight, is classified as a "consumer discretionary" company, Alphabet (GOOGL) (GOOG), which as a 3.7% combined index weight, is classified as a "communication services" company, Tesla (TSLA), which has a 2.0% weighting is classified as a "consumer discretionary company," and Facebook (FB), which also has a 2.0% weighting, just behind Tesla right now, is classified as a "communication services" company.
Adding these four heavyweights to the technology sector takes the S&P 500's technology sector weighting to roughly 40%. Thus, roughly 40% of the S&P 500 Index is compromised of technology companies directly, and these companies have clearly benefited from lower long-term interest rates.
(Source: Author's Feb. 6, 2021 article)
Thus, while the technology sector of the broader equity markets has severely lagged the performance of the energy subsectors, as measured by XOP, XLE, and QQQ since March 23rd, 2020, which was shown above, very few investors have actually had a meaningful weighting to the energy sector, as its S&P 500 Index weighting had fallen below 2.5% early in 2021.
This potential development was foreshadowed was the prescient commentary from Murray Stahl of Horizon Kinetics, who offered this persuasive take, that I happen to agree with wholeheartedly, on what's wrong with the structure of the index today, which was presented in a question and answer format in Horizon Kinetics' Q2 2020 investment commentary. Here is the section I want to highlight today (with emphasis added my own).
Murray Stahl: I personally think that indexation, which has really been a 20-25-year phenomenon in terms of raising assets and becoming unquestionably the dominant investment strategy, is just about ready to come to its end. And I say that because I think the index methodology is going to prove, at the end of the day, to be stenotic, narrowing to the point of failure.
There are a number of good characteristics about indexation, because, anything can be a good if you don’t take it to an extreme. But that’s a problem with investing, which is a problem in social science: People take things to extremes. They also lack patience, but the bigger problem is they take things to great extremes. No investment strategy is a strategy for all times. The indexation strategy is a good idea in the sense that, in theory, it is a diversified portfolio with exposure to basically everything that’s in the market. So, some elements in the index will do well and, obviously, some others will not, but in the fullness of time, assuming the market as a whole does well, the whole of the index should do well.
And in the last 20 years, at least the part of the index that is technology, which is now clearly its biggest element, has done outstandingly well. And it’s obvious how that happened: Because of the growth of the internet, from a handful of users to now, if I’m not mistaken, over 4.8 billion of the roughly 7.7 billion people on this planet. The growth rates, if you measure country by country, are just astonishing. And a lot of that internet activity is concentrated on the platforms of certain companies, and you know which ones they are: Amazon, and Microsoft (MSFT), and Facebook, and Apple, and Google.
So, they’ve been incredible growth companies. And I don’t believe that they are going to be unprofitable. I’m not really saying anything bad about them. I’ll only say two things, one of which is completely obvious. By definition and by simple math, there’s a clear and calculable limit to how much growth they’re going to have in the sense that if we’re at almost 4.8 billion users and there are only 7.7 billion people on the planet, well, then, the maximum cumulative growth in users can only be the 60%, that being from the current number of users to 7.7 billion, and that’s if every single human on the planet is connected. Which means you’re not going to get the returns of the past. I personally think that’s self-evident, but as I look around at sales projections, no one else seems to agree with me.
More importantly, let’s just imagine the following possibility: Let’s just say something else, some other segment of the index – of the S&P 500 – is going to do extraordinarily well at some point in the future. Well, if that’s true, the problem is that the index is now dominated by a handful of companies, meaning that it has undiversified itself and might no longer have much exposure to that other segment that will do extraordinarily well in the future. Many people don’t think about this, but that eventually happens to every index: Sooner or later, even if every stock in an index goes down, some stock is going to be the best-performing one, and that’s going to become the biggest position, and the next best performing stock is going to be the second biggest position, and eventually the index will be heavily dependent upon some particular few companies or sector.
This undiversifying happens over a very extended period of time and, because of that, this phenomenon hasn’t been studied – but in our case, that time is now. The S&P 500 is now a concentrated portfolio, and has undone the logic of its original purpose and is not diversified at all. The top five companies, out of 500 constituents, now account for 21% of the index.
The problem is not that something horrific will befall the largest investments, although that can happen, of course. In all likelihood, they will remain profitable. The problem – and perhaps the least appreciated one – is that some other group in the index will become desirable, but its exposure will have become negligible within the index as it gets crowded out. Hence, no matter how high the return of the negligible part of the index, it will have virtually no impact upon the total index.
So, imagine you were in control of the S&P 500 index, and you would like to rebalance it in order to give it exposure or greater exposure to some other sector of the economy. And let’s just make believe that sector is energy. Now, here I’m just asking you to admit the possibility. I understand it’s very controversial. I’m not making an argument that energy is going to do well. I’m just saying theoretically there’s a possibility that energy might do well, and you’re in control of the index and you want to alter the weightings such that energy, which is now not even 3% of the index, is going to be higher. How much higher? Let’s say you wanted to make it 15%. How would you actually go about doing it? Well, arithmetically it’s pretty easy. You would come up with a formula, and the computer would do the rest of the work. And once upon a time, you could even do that.
But in another way, it’s impossible. Why? Because, in practice, most of the investment world is now indexed, so this theoretical rebalancing would take place at a time when indexation is the dominant strategy – which never happened before. And it becomes more dominant with every passing day as the world divests itself of its active management community. In fact, rebalancing is impossible in two separate but completely related, ways.
Here’s the first problem: There’s no longer enough money being managed in the active investment community to accommodate such a change. All the major indexes – and it’s not just the S&P 500, because they all have so much overlap in holdings – are going to be doing the exact same thing. They’ll want to sell their leading positions to rebalance, but who in the world are you going to sell to, even if they wanted to buy them? The buyers, the active managers, don’t have enough money. So, you can’t change or rebalance the index.
And, second, why should they buy it? The terms of trade are about to change radically in favor of the active management community, small and battered though it may be.
(Source: Horizon Kinetics' Q2 2020 Investor Commentary)
Bottom line, what was hypothesized has actually happened, meaning the sector of the market, or the sectors of the market that have outperformed the most, have been severely underweighted by investors. This has happened because of the pervasiveness of indexes, and their surging popularity over the past decade, and due to investor's collective time-honored habit of chasing performance.
The end result is that tsunami of price insensitive and valuation insensitive buying has effectively positioned investors in the most overvalued assets, and even the vaunted Dow Jones Industrial Average was complicit in this price action, as they effectively caused the selling of millions and millions of shares of Exxon Mobil near their lows, while causing many investors to buy Salesforce.com near its recent highs.
Closing Thoughts: The Reversion To The Mean Trade Has Just Begun
Thirty years into the future, when we look back in market history, I think investors will recognize that the removal of Exxon Mobil, the oldest component in the Dow Jones Industrial Average (it was first added in 1928) from the index on Aug. 31, 2020, marked a seminal point in market history. This arbitrary action by S&P Global effectively put the exclamation point on what was a historic run of growth outperformance, led by many structurally unprofitable or barely profitable ESG favorites like Tesla, while potentially marking the end of both this growth outperformance and the end of price insensitive and valuation insensitive passive and ETF buying.
Obviously, we are too near the event to understand its full ramifications, however, the outperformance of Exxon Mobil shares vs. Salesforce.com shares since Aug. 31, 2020, where Exxon Mobil shares have risen 56.3% and Salesforce.com shares have declined 24.6%, shows how different performance has been for the shunned out-of-favor assets compared to the hyped in-favor assets over the past roughly six months.
From a bigger picture perspective, there's a current backdrop of rising interest rates that investors are struggling with today as the lower for longer narrative is challenged and commodity prices are signaling that we are on the cusp of higher than expected future inflationary pressures. Additionally, and adding complexity, is the fact that we appear to be in the mist of a historic capital rotation that is now in full bloom.
This could very well lead to the specter of a burst broader equity market bubble, and a burst bond market bubble. On this note, the iShares 20+Year Treasury ETF (TLT) is down 11.7% year-to-date as I write this article. Ultimately, rising interest rates, compressed profit margins, and the outflow of investors who crowded into unprofitable growth investments could potentially cast a pall over the broader investment landscape, as the expected annualized real return forecast from GMO shows below.
Personally, I have tried to add perspective to what this real return forecast suggests, using 2000 and 2008 comparisons in the table I have put together that is shown with the following graphic.
(Source: Author, GMO)
With both stock and bond valuations in nosebleed territory, the overlooked answer to asset allocations that may be hiding in plain sight is an overweight to commodities, and commodity equities, which are historically non-correlated assets. This has played out real time, as described in this article, with the relative and absolute outperformance of Exxon Mobil shares, and more broadly, energy shares over the past six months, and since the March 23, 2020, equity market bottom.
Commodity equities, in particular, are still very cheap and out of favor, even if they have risen from the bargain-basement levels of August 2020.
(Source: Longview Economics, Macrobond)
Wrapping up, I have been pounding the table on the extremely out-of-favor commodity equities for a long time now, and I still think we are in the early innings of what will be a longer-term price appreciation. Investors skittish of the commodity sector should research cast aside financials as they will also benefit from rising inflationary expectations and rising long-term interest rates. Understanding the bigger picture, then having an understanding of the bottoms-up fundamentals has been the key to outperformance, and this is a path that has not been easy with those participating confirming this reality. However, the road less taken is sometimes the better ones, and I firmly believe that today, as traditional stocks, bonds, and real estate offer very poor starting valuations, and very poor projected future real returns, from today's price levels. More specifically, the out-of-favor assets and asset classes, including commodities and commodity equities, and out-of-favor specific securities are where the historic opportunity has been, and that's where it still stands, from my perspective.
There is historic opportunity in the investment markets today. I have spent thousands of hours analyzing the markets, looking for the best opportunities, looking to replicate what I have been able to accomplish in the past. From my perspective, the opportunities in targeted out-of-favor equities today are every bit as big as the best opportunities in early 2016, and late 2008/early 2009. For further perspective on these opportunities, consider a membership to The Contrarian, sign up here to join.
This article was written by
Twenty plus year career as an investment analyst, investor, portfolio manager, consultant, and writer. Founder of Koldus Contrarian Investments, Ltd, which was incorporated in the spring of 2009. Dyed in the wool contrarian investor, who has learned, the hard way, that a good contrarian is only contrarian 20% of the time, but being right at key inflection points is the key to meaningful wealth creation in the markets. I believe we are near a meaningful inflection point, perhaps the biggest one yet, for the third time in the past 15 years.
Historically, I have had huge wins and impressive losses based on a concentrated, contrarian strategy. Trying to keep the good while filtering out the bad.Seeking to run an all weather portfolio with minimal volatility and index overlays to capture my strategic and tactical recommendations along with a concentrated best ideas portfolio, which is my bread and butter, but the volatility only makes it suitable for a small piece of an investor's overall portfolio. The following are a couple of my favorite investment quotes.
"Life and investing are long ballgames." Julian Robertson
"A diamond is a chunk of coal that is made good under pressure."
"Knowledge is limited. Imagination encircles the world." Albert Einstein
I’ve been on top of the world, and the world has been on top of me. I have learned to enjoy the perspective from each view, and use opportunities to persistently acquire knowledge, and enjoy the company of those around me, especially loved ones, family, and friends.At heart, I am a market historian with an unrivaled passion for the capital markets. I have had a long history and specialization with concentrated positions and options trading. Made money in 2008 with a net long portfolio, deploying capital in some of the market's darkest hours into long positions including purchases of American Express, Atlas Energy, Crosstex, First Industrial Real Estate, General Growth Properties, Genworth, Macquarie Infrastructure, Ruth Chris Steakhouse, and Vornado near their lows. Shorting, hedging, and option strategies also helped me in 2007 and 2009, and these are skills that I have developed ever since I started trading heavily in 1996.I enjoy reading, accumulating knowledge, and putting this knowledge to work in the active capital markets, learning lessons along the way.To this day, I continue to learn, and some of these learning lessons have been excruciatingly difficult ones, especially over the past several years, as I made mistakes allocating capital, including a sizable portion of my own capital (I always invest alongside my clients), to commodity related stocks. While all commodity related stocks have struggled since April of 2011, coal companies, which attracted me due to their extremely cheap valuations, and out-of-favor status (I am a strong believer in behavioral finance alongside fundamentals and technicals) have been the worst investing mistake of my career. The focus on the commodity arena has been the biggest mistake of my investment career thus far, yet in its aftermath, I see tremendous opportunity, even larger in scope than the fortuitous 2008/2009 environment.The capital that I accumulated and the confidence gained in navigating the treacherous investment waters of 2008 gave me the confidence to launch my own investment firm in the spring of 2009, right before the ultimate lows in the stock market. At the time I was working as a senior analyst at one of the largest RIA's in the country, and I felt strongly that the market environment was the best time since 1974/1975 to start an investment firm.
Prior to starting my firm, I was a senior analyst for three different firms over approximately 10 years (Charles Schwab, Redwood, Oxford), moving up in responsibility and scope at each stop along my journey. Since I was a paperboy, I have always had an interest in the investment markets. I love researching and finding opportunities. I was a Chartered Financial Analyst, CFA from 2006-2018. Additionally, I have been a Chartered Alternative Investment Analyst, CAIA. After starting in the teaching program at Ball State University, I switched to a career in finance when I turned a small student loan into a substantial amount of capital. I graduated summa cum laude with a degree in finance from Ball State.
Full disclosure, I am not currently a registered investment advisor, though I did serve in this capacity from 2009-2014, while owning Koldus Contrarian Investments, Ltd. Additionally, I held various securities licenses from 2000-2014 without a single formal complaint filed. At the end of 2014, I voluntarily let my state registration expire, as I transitioned the business to a different structure after going through a brutal business environment, divestiture and difficult divorce and custody battle. Prior to this, I had passed, and held, various securities exams and licenses, including the Series 7, Series 63, and Series 65 exams, in addition to others, alongside the CFA and CAIA designations. Unfortunately, I did not file the proper paperwork to withdraw my state registration, and I did not disclose a personal arrangement, and subsequent civil case, between myself and a former close personal friend and client. This arrangement was initiated informally in 2011, after a substantial period of success, as we aimed to be business partners, and it ultimately resulted in a dispute. I was unaware that I was required to disclose these items, and my securities attorney, at the time, did not advise me to do so. Previously, I had managed a portfolio for this gentleman, and we had taken an investment of approximately $7 million in 2009, and grown it to over $25 million at the beginning of 2012. After a very difficult year of performance, an employee of the firm I owned, and friend, resigned in early 2013, and took the aforementioned client to a competing firm. As a result of not filing the proper paperwork, I agreed to a settlement, with a potential $2500 fine in the future, depending on if I choose to reapply to be a non-exempt advisor. Additionally, while going through the difficult divorce and business dispute and divestiture, I did not file the proper disclosure on two of the annual CFA renewals. As a result, the CFA Institute sought a 3-Year Suspension of my right to use the CFA designation, which I appealed, since the primary investigator in the case sought a 1-year suspension of my right to use the CFA designation for a majority of the investigation. A Hearing Panel heard the case, and went against the recommendation of the CFA's Institute's Professional Conduct Department. Long story short, be careful who you trust, especially when substantial money is involved, and always disclose everything properly, which is hard to do when you are going through difficult situations, as this is the last thing you are probably thinking of at the time. In closing, I have had more experience in the markets, business, and life than most, yet I am grateful & thankful for every day. Additionally, I have learned through success and failures that you have to move forward, and if you can do this, your life will form a rich tapestry of stories.
Analyst’s Disclosure: I am/we are long XOM, CVX, X, AND SHORT SPY AND TLT IN A LONG/SHORT PORTFOLIO. 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.
Every investor's situation is different. Positions can change at any time without warning. Please do your own due diligence and consult with your financial advisor, if you have one, before making any investment decisions. The author is not acting in an investment adviser capacity. The author's opinions expressed herein address only select aspects of potential investment in securities of the companies mentioned and cannot be a substitute for comprehensive investment analysis. The author recommends that potential and existing investors conduct thorough investment research of their own, including detailed review of the companies' SEC filings. Any opinions or estimates constitute the author's best judgment as of the date of publication, and are subject to change without notice.
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