oil …again

After a long period of the stock market thinking that lower oil prices are a good thing (for all sectors except Energy), the market now appears to have adopted the opposite view.

Over the past short while, when the spot price, a mere shadow of its June 2014 self, moves down, so too does the S&P 500.  Economically sensitive stocks get clunked more than the average equity.   And vice versa.

To me, this seems so obviously wrong   …and yet it’s happening.

This wouldn’t be the first time that the market got a crazy idea into its head and ran with it for a while.  Remember in 2009 when a number of prominent hedge fund managers proclaimed that the Fed’s decision to lower interest rates would quickly cause runaway inflation and that the only protection against this government folly was to stockpile gold?

Here we are six years later, with still no inflation to speak of.  Gold had an amazing two-year run, which had nothing to do with the Fed, and everything to do with demand for the yellow metal in India and China.  The gold price has since lost 40% of its value as new mine supplies have come into the market and as domestic developments in Indian and China have lessened their ardor for money-like stuff they can bury in the backyard.

It’s tempting to think that the reversal of view about oil is only occurring because most big market participants have closed their books for the year and are drinking egg nog on the sidelines.  But I think it’s a dangerous habit to cultivate–the idea that I’m right, the market’s wrong and it will soon come to its senses.  The reality is that I’m wrong maybe 40% of the time.  Also, it could be that soon is the operative word.

At times like this, I go through this mental checklist:

  1.  How dependent is my portfolio on this one idea?  The riskiest situation is one where my holdings end up being an all-or-nothing bet on a falling oil price being good, without my realizing it.
  2. How likely is it that, contrary to my view, the market turns out to be right?
  3. If I wanted to rearrange my holdings to neutralize the effect of lower oil–meaning, in this case, becoming more defensive–how would I do it?  Would these changes make any difference to my performance expectations?  If not, why don’t I make them?
  4. If I were managing professionally, I’d ask if I should do some of this in any event, to guard against falling behind my peers (and ultimately getting fired–even worse, maintaining a portfolio that would pay off spectacularly for my replacement).

Most often, when I go through this process I find something in my portfolio that I don’t like and change it.  Invariably the move improves my performance.  But most often it has nothing to do with my original worry.

As to the market’s current fixation on oil, I have three thoughts:

–for now I’m content with what I hold and hope to ride out the craziness,

–I think this latest market kerfluffle brings us closer to the day when we’ll want to add oil exposure, and

–downward pressure on the market in December will translate into somewhat higher returns in 2016.


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