EQT Corp Up 49.1% Last Week; Inflection Point Is Here

EQT Corp Up 49.1% Last Week; Inflection Point Is Here

Mar. 17, 2020 8:54 AM ET|About: Antero Resources Corporation (AR)EQTSPYUNGXOMSummary

EQT Corp, the largest dry natural gas producer in the U.S., gained 49.1% last week.

Many natural gas equities had stellar performance weeks, while SPY dropped 9.5%, and historic volatility engulfed the markets.

Looking through the volatility, the inflection point is clearly at hand.

Introduction

There has been historic volatility in the financial markets.  That is not hyperbole, as the chart of the $VIX shows below.

In fact, even though the SPDR S&P 500 ETF (SPY) declined 9.5% last week, we have seen daily price moves, on a regular basis, that exceed that move.

In this swirling sea of turmoil, one sector that I have extremely bullish on stands out.

Specifically natural gas, and more specifically, the historically downtrodden natural gas equities, which have both been contrarian trades and investments even for contrarians.

Dry natural gas prices rose 9.4% last week, the United States Natural Gas Fund (UNG) rose 10.7% last week, and the largest dry natural gas producer in the United States, EQT Corp (EQT), rose 49.1% last week.

Macro Is Turning Sharply To Favor Natural Gas

Anybody that has been reading my work knows that I have been extremely bullish on natural gas prices and natural gas equities.

Why?

In a nutshell, both lower 48 dry natural gas production and liquids production are rolling over, as the charts of my colleague Lothar Grall illustrate.

(Source: Lothar Grall, The Contrarian)

Keep in mind, this data is from the EIA’s Drilling Productivity Report, and production was already in decline for dry natural gas and rolling over for liquids before COVID-19 became a full blown pandemic, and Russia and Saudi Arabia got into a full scale oil war.

The latter has cratered crude oil prices, and effectively rendered obsolete the primary bearish natural gas thesis, which was that unending associated dry gas production growth would forever impair dry natural gas prices.

Natural Gas Equities Have A Contrarian Surge

Again, last week, with the SPDR S&P 500 Index down 9.5%, the largest natural gas producer in the United States, EQT Corp (EQT), surged higher by 49.1%.

That is a monumental move, in a week of historical market volatility, and adding to the narrative, many of the leading dry natural gas producers had a strong week of relative, and absolute, price performance.

As this narrative begins to flow through to market participants, there is potential for extraordinary gains, perhaps even a generational wealth opportunity, as I wrote about in an article highlighting Antero Resources (AR) recently, in some of the largest dry natural gas producers in the table above.

On this note, much beleaguered Exxon Mobil (XOM), which is widely ridiculed for their XTO energy purchase in 2009, which gave them greater natural gas exposure, could get a material, unexpected (by many market participants) boost from higher dry natural gas prices.

Closing Thoughts – Take Advantage Of What I Think Is A Historic Opportunity

Many always ask me how I had a year like I did from November of 2008 to November of 2009.

The answer was really simple.

1. Have an accurate bigger picture macroeconomic view.

2.  Identify opportunities that are mispriced by the markets.

3.  Take advantage of the panic selling.

Fortunately, for market participants today, we have all the ingredients necessary for one of the great contrarian inflection points of all-time.

For members of my research services, I have published several recent pieces quantifying the historical volatility and the opportunity as follows:

Chronicling Another Historic Day In The Market & Putting Together A Buy List

Another Historic Market Day This Week – Chronicling Black Thursday & Looking Forward

Chronicling A Historic Day In The Stock Market & A More Historic Day In The Energy Market

(Note: Members can click on these articles to access.  Also, the first article is still being distributed).

Somewhat unbelievably, we have had three historic days in the stock markets in the past six trading sessions, really four historic days counting Friday’s big gains, so the volatility is incredible.

Seeing through all of this volatility, there are clear inflection points at hand, and the relative and absolute opportunity right now is as big as I have seen in my 25 year plus personal and professional investment career.

In summary, buy what is cheap, and buy into the panic, as the cheapest valuation equities with the best future return prospects will often rebound ahead of a bottom in the broader equity market.

Specific to my research services, I am offering a 20% discount to membership (I am extending this through March) to “The Contrarian” (past members can also direct message me for a special rate), the lowest price point since the founding members price, where we have a live documented history dating back to late 2015.

Additionally, I am offering a limited time 50% discount for the first 10 new members (I expect these slots, some of which I view as a stepping stone to “The Contrarian”, to fill up fast as they have done previously) to a host of research options, including a lower price point. If you subscribe to a premium option (I have had one concierge slot open up), I will set-aside time for a personal phone call to get up to speed. To get these offers, go here, and enter coupon code “opportunity” without the quotes.  Either way, once you sign up, I will follow-up with a welcome email within a day.

Reach out with any questions via direct message (I enjoy the dialogue at market inflection points).

Via my research services, or another avenue, please do your due diligence, and take advantage of what I believe is a historic inflection point, which I believe will supersede 2000-2002 in the growth-to-value rotation.

WTK

P.S. Resilience is perhaps the most important ingredient to be successful in life, and in the markets. Keep that in mind right now.

Disclosure: I am/we are long AR, EQT, UNG, XOM, and short SPY in a long/short portfolio.

Additional disclosure: 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.

Use Panic Selling To Your Advantage

Use Panic Selling To Your Advantage – Highlighting A 14% Yielding Model Portfolio

This article was originally written on February 27th, however, I am posting here for the archives.

Feb. 27, 2020 1:42 PM ET|11 comments |About: Brookfield Property Partners L.P. (BPY)MICSPYXOMXOP, Includes: BPYPPGNWOXYSLBSPGSPG.PJSummary

Panic selling in the broader stock market may have just begun.

Under the surface, panic selling has been ongoing in selected sectors and stocks for an extended period of time.

This presents the historic opportunity.

Introduction

Often, I get the question of how I have achieved out-sized returns (and losses) in the past, particularly with an emphasis on what I have been able to do in my very good years, including 2016, 2003, 1999, 2000, 2008, 2010, and most notably 2009, as illustrated by the snapshot of an aggressive Portfolio that I managed personally for myself below, where I took roughly $60,000 in November of 2008 to over $3 million by November of 2009.

How did I achieve the above returns, over 5000% in a years time (which BTW I may never top, however, knowing this reality, does not stop the pursuit of good years, particularly at inflection points)?

There is a lot of complexity in the answer, including having a variant view, specifically on the broader market as measured by the S&P 500 Index (SPY), using some leverage to express this view, primarily via options, which can be very dangerous tools in inexperienced hands, and the willingness/ability to go against the grain. 

Having said this, there is also a lot of simplicity in the answer, specifically in the main underlying driver of the returns, which was buying significantly out-of-favor equities, with one example being my March 2009 and April 2009 purchases of Macquarie Infrastructure (MIC) for roughly $2 a share.  Famously, MIC got down to $0.79 (before dividend adjustments…so I was down roughly 60% on even what I thought were bottom ticking purchases…think about that for a minute) and topped $80 per share, again before dividend adjustments, while also reinstating a substantial dividend, that has been roughly $1 per quarter for some time now (this dividend had been suspended in 2009 before being reinstated).

Clearly, with the benefit of hindsight, purchasing MIC at the lows was a generational investment opportunity, however, it was not easy at the time, even though I had done thousands of hours of due diligence on the company,  similar to the focused due diligence effort I have done today, on out-of-favor, undervalued securities.  

The key was buying into the panic selling, taking advantage of the panic, and I think we are seeing similar levels of opportunity today, just not in the places that most investors want to look.

Buying Into The Panic

In my November 2008 to November 2009 example above, I actually started buying what I felt were the most distressed, highest return potential candidate equities in 2008, in the heart of the panic.  Remember, the broader equity market did not bottom until March of 2009, which is a whole other story, however, the important point is that some of the most downtrodden equities made their lows prior to the broader market making its lows.

One specific example, is General Growth Properties, the former second-largest mall REIT in the U.S. behind Simon Property Group (SPG), that was eventually acquired by Brookfield Property Partners (BPY) in 2018.

In November of 2008, I was on a due diligence trip through South Florida, meeting with hedge fund managers, and asset managers, and after a legendary night out for this generally non-party owl author (ask me for details if you want), I awoke in my Miami Beach hotel room, looking out at the ocean, and taking in the panic, eventually buying 120,000 shares of GGP on November 14th, 2018 for this specific account, as my brokerage account statement shows (if you want additional details send me a direct message).

These purchases, in aggregate, totaled $53,593.71, which was not a big dollar total in aggregate, however, the 120,000 shares were a nice stake in what would become the best performing S&P 500 equity in the bull market, at least through March 10th, 2017, as this CBS MarketWatch article on the bull market turning 8 years old chronicled.

In March of 2018, in the Brookfield Property Partners deal, these shares could be exchanged for $23.50 in cash.

Not a bad return at all, however, the key was to buy into the panic.

Where Is The Panic Today

Even though the S&P 500 Index is on track to be down 7% or more this week, as I write this post, the real panic is not in the broader stock market, at least not yet.

In fact, on a long-term chart, the recent decline is just a blip.

Now, we could be on our way to a broader stock market sell-off, as GMO has previously outlined earlier in 2018.

Regarding the path of the broader markets, that is yet to be determined, as we grapple with historically extended valuations, and historical monetary policy accommodation levels. 

The real panic right now is in the underbelly of global economic activity, specifically in economically sensitive cyclical stocks, and more specifically, in the most loathed of all stock market sectors today, which is of course, the energy sector.

The SPDR S&P Oil & Gas Exploration & Production ETF (XOP) offers a glimpse of this panic, with XOP down 79.8% from its 2014 high, and down 63.8% from its 2018 high.

Thus, with the broader U.S. stock market, as measured by SPY, only down roughly 8% from its recent highs, the compare & contrast should be eye opening for most investors.

Building on the narrative, with our deep research dives, we feel there are a number of out-of-favor equities that are down even greater in percentage terms, which offer even greater relative and absolute opportunity.

Importantly, similar to several of the downtrodden equities I purchased in late 2008, and early 2009, including General Growth Properties, and Genworth Financial (GNW), which was also bought well below $1 in November of 2008 before shares rebounded above $18 by early 2010, the most out-of-favor, undervalued equities right now, will probably bottom ahead of the bottom in the broader equity market.

Panic Selling Is Yielding Opportunity

It is no secret that I am targeting what I believe are the most undervalued securities, with the goal of creating a generational wealth opportunity.  These securities are generally loathed, unloved, and scorned right now, and many of these equities would make your stomach turn looking at long-term charts, part of the reason there is so much opportunity.

While the best opportunities are generally in smaller capitalization names, there is opportunity in large-caps, including in energy stalwarts like Exxon Mobil (XOM), Occidental Petroleum (OXY), and Schlumberger (SLB), all of which offer attractive yield-oriented income opportunity.

These three securities are part of a “Stuck On Yield” Model Portfolio, which is a $100,000 portfolio, that I created on Friday, February 21st, for a family member.

This Portfolio is yielding over 14% right now, and I have done deep-dive due diligence on all its member components, a majority of which are from the target rich energy sector.

Members of The Contrarian can see this Model Portfolio here, and I have sent out emails of this Portfolio to members of my research services, and I will be making it available this week for all my research members.

Closing Thoughts – Be Ready To Buy Now

Nobody, including me, really knows where the stock, bond, and commodity markets are headed right now with certainty.  All we have is probabilities, and ultimately, our valuation analysis.  The latter is crucially important, as buying the most undervalued assets, ultimately leads to the strongest returns, so long as you can ascertain the underlying asset quality, and survivability of the corporate entity.

On this note, I am going to make mistakes, so the key is getting a handful of these right, as the gains from the survivors will more than make up for any losses, at least that is my past experience at previous inflection points.  Ultimately, valuation matters, and starting valuations levels matter too.  Adding to the narrative, with everyone wanting to own quality today, there are many “Have Not” securities that are historically undervalued.

Conversely, a high valuation is a bad starting point, and buying overvalued assets, which certainly describes the S&P 500 Index, which trades at greater EV/EBITDA, Price/Book, and Price/Sales multiples that it did at its peak valuation levels in late 1999/early 2000, is a recipe to achieve poor returns going forward.  Adding salt to the wound, the bond market, which offers meager sovereign yields, is also set-up for poor future returns over the longer-term, as historically over 90% of bond returns are correlated with starting yields.

In summary, buy what is cheap, and buy into the panicas the cheapest valuation equities with the best future return prospects will often rebound ahead of a bottom in the broader equity market.

Specific to my research services, I am offering a 20% discount to membership (I am extending this through March) to “The Contrarian” (past members can also direct message me for a special rate), the lowest price point since the founding members price, where we have a live documented history dating back to late 2015..

Additionally, I am offering a limited time 50% discount for the first 5 new members (I expect these slots, some of which I view as a stepping stone to “The Contrarian”, to fill up fast as they have done previously) to a host of research options, including a lower price point.  If you subscribe to a premium option (I have had one concierge slot open up after a gentleman I was speaking to last evening held off on taking this slot), I will set-aside time for a personal phone call to get up to speed.  To get these offers, go here, and enter coupon code “opportunity” without the quotes.

Reach out with any questions via direct message (I enjoy the dialogue at market inflection points).

Via my research services, or another avenue, please do your due diligence, and take advantage of what I believe is a historic inflection point, which I believe will supersede 2000-2002 in the growth-to-value rotation.

WTK

P.S. Resilience is perhaps the most important ingredient to be successful in life, and in the markets. Keep that in mind right now.

Disclosure: I am/we are long MIC, OXY, SLB, xom and short spy in a long/short portfolio.

Additional disclosure: 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.

EQT Corp Finished Up 49.1% Last Week

The largest natural gas producer in the United States had a remarkable week in the middle of market turmoil.

For the week, with the S&P 500 Index (SPY) down 9.5%, EQT Corp (EQT) rose 49.1% for the week.

Natural gas (UNG) prices also rose 9.4% for the week.

Meanwhile, oil prices (USO) declined 23.1% for the week.

Bigger picture, price action is telling us that major inflection points are at hand. Best of luck to all.

Volatility Is Above 2008 High Levels As Dow Jones Industrial Average Has 2nd Worst Percentage Decline

Volatility Index Sets New Highs

This is just a short post to document something remarkable.

Volatility is actually above 2008’s high levels.

With the Dow Jones Industrial Average (DIA) posting is second worst percentage decline ever, and a cluster of recent days on the worst performing days list, perhaps the jump in volatility amid the COVID-19 pandemic should not be a surpise.

Adding to the narrative, the S&P 500 Index (SPY) posted its third worst percentage decline day ever.

Ultimately, volatility is opportunity, and this elevated volatility will not be around forever. Thus, I think market participants should be making their shopping lists for what to own on the long side.

The Signal Event Is Potentially Here

I originally wrote this Monday morning, February 24th, before the market opened here, however, I want to post here for archives.

The Signal Event Is Potentially Here

Feb. 24, 2020 7:08 AM ET|2 comments |About: SPDR S&P 500 Trust ETF (SPY), Includes: AAPLAMZNBACBAC.PABAC.PBBAC.PCBAC.PEBAC.PKBAC.PLBAC.PMBML.PGBML.PHBML.PJBML.PLBRK.ABRK.BCC.PKC.PSCMCSACPRJCVXDISFBGOOGGOOGLHDINTCJNJJPMJPM.PCJPM.PDJPM.PFJPM.PGJPM.PHKOMAMRKMSFTOPEPPGQQQTTBBTBCUNHVZXOM

Summary

  • I have been waiting for a long time for a set of events to end the virtuous melt-up, fueled by passive and ETF fund flows.
  • Coronavirus could be the black swan that causes a reversal of these fund flows.
  • Non-correlated equities with low index representation stand to benefit disproportionately.

Introduction

We are potentially on the verge of an historic capital rotation from growth to value, sparked by black swan catalysts that nobody envisioned a short time ago.

Building on this narrative, on February 6th, 2018, I wrote one of my most popular articles published on Seeking Alpha titled, “Be Prepared For A Crash – Part II“, and in the article, I specifically investigated the lack of price discovery in the markets, as passive, ETF, and dividend growth fund flows were largely price insensitive and valuation insensitive in their endless buying.

Today, that virtuous, seemingly never ending cycle has the potential to work in reverse fashion.  In Steven Bregman’s words, all that was needed was a signal event to jump start a golden age for active investors, and we may have one transpiring in real time. 

The Signal Event Could Be Happening Right Now

In a September 21st, 2017 article I authored for members of The Contrarian, titled, “Investment Philosophy – A Golden Age For Active Investors Awaits“, I pontificated on how there was very little price discovery in the market.

To illustrate this point, I referenced several quotes from Steven Bregman, president and co-founder of Horizon Kinectics, who presented at James Grant’s October 4th, 2016 Investment Conference.

Here is the first set of quotes I referenced:

“A golden age of active investment management awaits only one signal event, Steven Bregman, president and co-founder of Horizon Kinetics, told the Grant’s conference-comers on Oct. 4. A collapse of the index/ETF bubble is that intervening disaster. To hear Bregman tell it, no crash would be so well-deserved

He called the exchange-traded fund excrescence the world’s biggest bubble.

“It has distorted clearing prices in every sort of financial asset in every corner of the globe…,” asserted Bregman. “[I]t has created a massive systemic risk to which everyone who believes they are well diversified in the conventional sense are now exposed.”

I could not agree more with the statement quoted above, and these price distortions have increased at an exponential rate from 2017-2019, and early into 2020, as crowded trades have become more crowded.

Conversely, the “Have Not” equities have been shunned to an even further degree, creating the most bifurcated market that I have seen in my 25 plus years actively investing and speculating.

A Historic Capital Rotation Is On The Horizon

Once passive, ETF, and index fund flows reverse, the disproportionately beneficiary equities, think the leading market capitalization index favorites, are going to be the equities that are hurt most by the reversal of fund flows.  Conversely, out-of-favor equities that have been shunned, will actually benefit, as long/short funds reduce gross market exposure, and net buying, at least net relative buying will head to these equities.

On this note, here are the 25 largest components of the SPDR S&P 500 Index ETF (SPY), which have all been buoyed by never ending passive fund flows.

  1. Microsoft (MSFT) – 5.0% weighting
  2. Apple (AAPL) – 4.8% weighting
  3. Amazon (AMZN) – 3.2% weighting
  4. Facebook (FB) – 1.8% weighting
  5. Alphabet Inc. Class A (GOOGL) – 1.6 % weighting
  6. Alphabet Inc. Class C (GOOG) – 1.6% weighting
  7. Berkshire Hathaway Inc. Class B (BRK.B) – 1.6% weighting
  8. JPMorgan Chase & Co. (JPM) – 1.5% weighting
  9. Johnson & Johnson (JNJ) – 1.4% weighting
  10. Visa Inc. Class A (C) – 1.3% weighting
  11. Procter & Gamble Company (PG) – 1.1% weighting
  12. Mastercard Incorporated Class A (MA) – 1.1% weighting
  13. UnitedHealth Group Incorporated (UNH) – 1.0% weighting
  14. Intel Corporation (INTC) – 1.0% weighting
  15. Bank of America Corp (BAC) – 1.0% weighting
  16. AT&T Inc. (T) – 1.0% weighting
  17. Home Depot Inc. (HD) – 1.0% weighting
  18. Exxon Mobil Corporation (XOM) – 0.9% weighting
  19. Walt Disney Company (DIS) – 0,9% weighting
  20. Verizon Communications Inc. (VZ) – 0.9% weighting
  21. Coca-Cola Company (KO) – 0.8% weighting
  22. Merck & Co. Inc. (MRK) – 0.8% weighting
  23. Comcast Corporation Class A (CMCSA) – 0.7% weighting
  24. Chevron Corporation (CVX) – 0.7% weighting
  25. PepsiCo Inc. (PEP) – 0.7% weighting

Personally, I think the top weighted companies on this list, which dominate the S&P 500 Index, and the Invesco QQQ Trust ETF (QQQ), have a chance to sell-off dramatically, if a true capital rotation takes hold from growth to value.

Given the current extended levels of growth versus value, there is a ripe opportunity for an epic price reversal.

Looking at the above, look how steep the price reversal was in 2000-2002, with the growth to value relationship reversing on a dime, and moving straight in the other direction.

Could the same thing happen today?

Yes, is my unequivocal answer, partly because the in-favor investment strategies and trades, think passive, ETF, and dividend growth fund flows, are even more popular today on a relative basis than they were in the late 1990’s, as almost every registered investment advisor in the U.S. has shifted to some form of passive indexing.

Wrapping up, coming from a value investment background, I have seen many of my peers ground to dust, and legendary value investors essentially take their ball and go home. Personally, I have more significant scars from this time frame than any other.

The collective price action and collective investor response is very reminiscent of Julian Robertson closing his Tiger Funds near the exact peak of the 1990-2000 bubble, an investment landscape that had seen Warren Buffett routinely criticized. Of course, this was followed by a massive reversion-to-the-mean trade from 2000-2002, and really 2000-2007, where value investing handily outperformed.

Building on this narrative, during 2000-2002, the S&P 500 Index lost roughly 50% from peak-to-trough, while many value stocks, including REITs, like Realty Income (O), which was loathed at the time, but loved today after roughly two decades of out-performance, surged higher, even with the broader market struggling mightily.

With that last thought in mind, consider what investments are loathed, and loved, today.

In closing, for the value investors that are left today, the odds seem insurmountable, however, the opportunities, particularly on a relative basis, are as big as they have ever been.

To get an idea of how I am positioning for this opportunity, since we are past there, in my opinion, I am offering a 20% discount to membership (I am extending this through February) to “The Contrarian” (past members can also direct message me for a special rate), the lowest price point since the founding members price, where we have a live documented history dating back to late 2015..

Additionally, I am offering a limited time 40% discount for the first 5 new members, repeating a successful promotion from earlier this month (I expect these slots, some of which I view as a stepping stone to “The Contrarian”, to fill up fast as they have done previously) to a host of research options, including a lower price point. To get this offer, go here, and enter coupon code “february 2020” without the quotes.

Reach out with any questions via direct message.

Via my research services, or another avenue, please do your due diligence, and take advantage of what I believe is a historic inflection point,

WTK

P.S. Resilience is perhaps the most important ingredient to be successful in life, and in the markets. Keep that in mind right now.

Disclosure: I am/we are long BAC, C, xom, and short AAPL via put options and spy in a long/short portfolio.

Additional disclosure: 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.

Everything Is A Function Of Interest Rates

We have clearly followed the path of the classic bubble that GMO laid out in 2008 for the S&P 500 Index ($SPX), (SPY), which is shown below.

The timeline has been slightly different, I call it an extended classic bubble, the slower ride to the final destination. Regardless of the course, we are here now.

The key question is where do we go from here, and the answer, from my perspective, is all a function of interest rates, particularly longer-term sovereign interest rates. With the yield curve close to inverting again, and two Fed Funds rates cuts priced in right now as of this writing (February 21st, 2020) through the December 2020 FOMC meeting, a lot of pessimism is priced in.

Additionally, sovereign interest rates are so low, the question needs to be asked, “How much could they go down in the next recession?”

Last, but not least, what if a recession is averted, or we experience a mild recession, similar to what happened in the midst of the 2000-2002 bear market. On this note, the current investment landscape reminds me an awful lot of late 1999/early 2000, with the moonshot blow-off in Tesla ($TSLA), and the greater concentration in the top-five S&P 500 names ($SPY), which are Apple ($AAPL), Microsoft ($MSFT), Alphabet ($GOOGL), ($GOOG), Amazon ($AMZN), and Facebook ($FB) than in late 1999/early 2000.

We all know how that story ended, however, almost all market participants have forgotten that 2000-2002 time frame, hyper-focused on a fear of a reprisal of 2007-2009, which has led us to where we are today.

And where is that, you may ask?

The answer is that we are on the cusp of a historical capital rotation. Stay tuned.

Quality Over All

Earlier today, a public article I posted about Antero Resources (AR) was published on Seeking Alpha. You can find it under this title & link, “Antero Resources Is A Generational Buy: Dispelling The Myth Of Antero As A High-Cost Producer“. While writing this article, and spending a lot of time researching commodity equities, and more specifically energy equities the past 5 years, really the past 7 years, that has snowballed to an almost obsession now, due to the inherent undervaluations, I have slowly worked to the conclusion that most market participants have become over obsessed with quality and/or perceived quality.

What do I mean by this?

In the case of Antero, almost all long/short fund managers I know, are long Cabot Oil & Gas, and short Antero. The relentless price action in favor of this trade, has essentially eradicated valuation sensitive and price sensitive money out the door.

Building on this narrative, the Darwinian survival funnel of the markets, has led almost all investors to the same securities the past decade, a ending place where quality and dividends are praised above all, and the perceived quality, and sustainability of dividend growth, and/or yield is worshiped.

The end result of this process is a bubble that is bigger than the late 1990’s bubble, more pervasive, and more driven by longer-term sovereign interest rates than anything else.

Wilshire 5000 Version

Looking back to 2018, GMO laid out a path for a classic bubble for the S&P 500 Index (SPY), and we are there, as the following graphic illustrates.

Looking at the above, once we peak, and roll-over, the path is frightening, something many market participants have some how forgotten following 2007-2009, and 2000-2002.

Really, though, it is worse than that, as yield-oriented investors have been pushed out the risk curve, and the perceived quality equities, namely the dividend payers, have become essentially the longest duration bonds.

I wrote about this with my Procter & Gamble (PG) public article, titled, “Procter & Gamble Is Historically Overpriced.”

Jumping straight to the punch line, what happens when almost all market participants embrace quality, perceived quality, and are piled into essentially the longest duration assets, chasing yield, when longer-term interest rates rise?

Who is prepared for this?

Will this lead to the historic bifurcation between the “Have’s” and the “Have Not’s” being closed?

My vote is a resounding yes!

Author’s Highlighted Posts – A Golden Age For Active Investors

  • Passive investing, and ETF investing, have dominated the last decade.
  • These unsustainable investing trends have created giant price distortions.
  • The next decade will be extremely lucrative for active investors and we are at an inflection point today.

(Travis’s Opening Note: This article was originally authored and published on September 21st, 2017, and it remains a “foundation article”, in my opinion, for my current investment stance, and it one of my favorite articles that I have authored.  It is being republished today, on 10/23/2018, to launch a new series category, which will be titled “Author’s Highlighted Posts”.)

“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)

“Be stubborn on vision and flexible on journey”

Noramay Cadena

Life and investing are long ballgames.”

Julian Robertson

Opening Note From WTK

When I worked at Oxford Financial Group, Limited, which was, and remains one of the largest RIA’s in the United States, I was hired by the CIO, Howard Harpster, who was the former head of BP Amoco’s (BP) pension plan. Howard was an intelligent, calculated risk-taker who cultivated relationships in the then opaque, and relationship-based, private equity, private real estate, and hedge fund arenas.

Howard eventually returned to his native Texas, which is near and dear to my heart, as I have many close relatives and friends in Texas, to sort through a family estate, and then take the role of CIO at the Texas Children’s Hospital.

Oxford conducted an executive search, on which I served a role, and narrowed the candidates for CIO to two individuals, ultimately hiring their current CIO in roughly late 2006 or early 2007.

The new CIO, who came from a background at Okabena, which was the family office created by the founding family of Target (TGT), embraced passive investing.

This firmly contrasted with my belief that the markets were not efficient, and we had a rousing discussion and debate for several years, both between the CIO and our broader investment strategy group, which was composed of four key decision makers, including myself, before I ultimately resigned, with good relationships in-tact, to start my investment firm in February of 2009.

At the time, I was full of confidence, as I had made money in 2008, when most investors and speculators lost money, and then I procured a small fortune, at least for me, from timely investments made in 2008 & 2009.

In the middle of 2008 and 2009, I thought it was a dream environment for active investors, and I could not see how the passive investment craze, that characterized the market’s rise from 2003-2007 could continue.

I was spectacularly wrong with this prediction.

Passive investing has dominated the past decade, making the shift to passive investments from 2003-2007 look like a blip on a long-term chart.

This has driven many active managers out of the investment industry (Travis’s Updated Note 10/23/2018: This purge has continued into 2018), accelerating the dispersion between passive investors and value investors, which has resulted in hedge fund closures, the decline of once prominent mutual fund families, and the downgrade in reputation to value investing and value investors.

This seemingly never ending, self-reinforcing, investment cycle has resulted in a bi-furcated market, where the favored investments of passive indexes, dividend growth strategies, and popular ETF’s are traded at some of the highest valuations in history, while equities outside these favored strategies trade at some of the lowest valuations in history.

In summary, this has created another dream environment for active investors, which is even better than 2008-2009 time-frame, in my opinion, and a golden age of active investing is right in front of investors and speculators, in my opinion.

We got a taste of this opportunity in 2016, but the market has not made the pendulum shift from passive investing being in-favor to active value investing being in-favor easy.  In fact, 2017 has been one of the most difficult, if not the most difficult years, of my investment career, thus far, but that should not take away from the scope, or magnitude, of the opportunity that is at hand.

Someday in the near-future, it is my prediction that investors will rue the fact that their equities are part of the benchmark indexes, and popular ETF strategies.  Thus, we sit on the cusp of a historic inflection point.  On this note, I came across a past issue of Grant’s Interest Rate Observer, from last October, about a week ago, that reinforced this point, and I wanted to write something about it, so here is that observation as part of my Investment Philosophy series.

Selected Prior Member Articles Of Interest On Investment Philosophy & Related Topics

Selected prior articles of interest for members on investment philosophy, market history, and portfolio strategy include:

Investing Philosophy – Abandoning Ship & Capitulation – 8/3/2017

Investment Philosophy – Identifying A Good Opportunity Is Only Half The Battle – 7/16/2017

Investing Philosophy – Staying Focused Is Hard To Do – 5/27/2017

Market Historian – What Happens When The Fed Raises Rates – 3/16/2017

Investment Philosophy – The Fallacy That You Always Need To Be Fully Invested – 2/2/2017

A Matter Of Perspective – Commodities & Commodity Stocks – 1/6/2017

Interview Series – Part II Of WTK’s Take On Edward Chancellor’s View With A Focus On Precious Metal Equities – 12/15/2016

Interview Series – WTK’s Take On Edward Chancellor’s View On “Intelligent Contrarian Investing” – 11/21/2016

Investment Philosophy For The Contrarian Subscribers – A Take From John Hempton @ Bronte Capital – 10/20/2016

The Contrarian’s Top-Ten Lists & Thoughts On Portfolio Strategy – 9/29/2016

Reviewing Lucas White’s And Jeremey Grantham’s Research On Commodity Stocks & A Market Note From WTK – 9/9/2016

Working Investment Thesis

It is my belief that we are in the final innings of the bull market that began in March of 2009, with bonds topping now, then stocks, and then commodities.

The Inspiration

Last week, I was reading, and researching, and I came across an October 14th, 2016 issue of Grant’s Interest Rate Observer, which was a recap of a presentation that Steven Bregman gave at Grant’s October Investment Conference.

I have been a subscriber to Grant’s Interest Rate Observer, and I am a fan of James Grant, who was born in New York City, but attended undergraduate college at Indiana University.  Mr. Grant has maintained ties to Indiana, including speaking as a guest speaker at the CFA Society of Indianapolis functions, which I have been involved with as a current member and past board member (I have also been a member of the Chicago CFA Society where Grant’s work has been featured).

This particular issue caught my eye, because it delved into the index/ETF bubble, which has been a topic that I have been writing about, and which I have been thinking about a lot lately.

A Passive Investing ETF Bubble

The opening paragraph describes the topic up for discussion, and the second paragraph spells out the views of Steven Bregman, president and co-founder of Horizon Kinectics, who presented at Grant’s October 4 th, 2016 Investment Conference, and like the famous line from Jerry Maguire, the presentation had me at hello.

Specifically, here is the opening paragraph and then the second paragraph, and then a screen shot that captures the broader discussion.

“A golden age of active investment management awaits only one signal event, Steven Bregman, president and co-founder of Horizon Kinetics, told the Grant’s conference-comers on Oct. 4. A collapse of the index/ETF bubble is that intervening disaster. To hear Bregman tell it, no crash would be so well-deserved

He called the exchange-traded fund excrescence the world’s biggest bubble. “It has distorted clearing prices in every sort of financial asset in every corner of the globe…,” asserted Bregman. “[I]t has created a massive systemic risk to which everyone who believes they are well diversified in the conventional sense are now exposed.”

Re-reading this piece, the amazing thing to be is that the passive investing/ETF bubble appeared to peak in 2016, yet roughly a full year later, the excesses have only been amplified.

No Factor For Valuation = No Price Discovery

The crux of Bregman’s case, and my argument too, is illustrated on page 2 of the linked report.  In these paragraphs, he deconstructs the iShares Emerging Market Bonds High Yield ETF (EMHY), and in doing so, he exposed the flaws of indexing, particularly when accomplished through ETF investing.  Here is a highlighted portion that I think makes a convincing point.

“By operation of law,” Bregman went on, “new money in EMHY is allocated based on float. In other words, the more debt a nation issues, the greater the allocation to its bonds because it has a greater capitalization. Petrobras (PBR) issues more bonds: greater index weight. Yes. The allocations must be done promptly and according to their precise index weights.

There is no factor in the algorithm for valuation,” our speaker noted. “No analyst at the ETF organizer—or at the Pension Fund that might be investing—who is concerned about it; it’s not in the job description. There is, really, no price discovery. And if there’s no price discovery, is there really a market? In which case, what is EMHY really worth?

This is about artificial supply-and demand pressures. Now, take this exercise and apply it to the equity indexes. That’s what’s going on. It’s just tougher to debate.”

The emphasis added through formatting was mine, because that is what is going on in the investment management industry.  As the former second CIO I worked under at Oxford aptly discovered, probably from “career threatening” mistakes at his prior CIO position at Okabena, there is no reason to take “career risk” when everybody is embracing the same way of investing, namely passive investing, and investing through ETF’s.

Building on this narrative, active investors, particularly active value investors, who were steamrolled from their purchases of financials and real estate equities in 2008 and 2009, negating their typical out-performance in bear markets, have been unable to serve as a check-and-balance to the “blind” passive money, because they have rapidly gone extinct.

Ultimately, this has harmed price discovery and further distorted valuations.

The ETF Divide

During the conference, Bregman highlighted how ETF’s have influenced stock valuations.  One specific example that stands out, and was illustrated, was the impact of ETF’s on Exxon Mobil (XOM).  Here are the paragraphs discussing its valuation and price performance from 2013-2016.

“Bregman lingered for a while on Exxon, a kind of ETF Swiss Army knife: “Aside from being 25% of the iShares U.S. Energy ETF, 22% of the Vanguard Energy ETF, and so forth, Exxon is simultaneously a Dividend Growth stock and a Deep Value stock. It is in the USA Quality Factor ETF and in the Weak Dollar U.S. Equity ETF. Get this: It’s both a Momentum Tilt stock and a Low Volatility stock. It sounds like a vaudeville act.”

Bregman proposed a mind experiment: “Say in 2013, on a bench in a train station, you came upon a page torn from an ExxonMobil financial statement that a time traveler from 2016 had inadvertently left behind. There it is before you: detailed, factual knowledge of Exxon’s results three years into the future. You’d know everything except, like a morality fable, the stock price: oil prices down 50%, revenue down 46%, earnings down 75%, the dividend-payout ratio almost 3x earnings. If you shorted, you would have lost money”—because the financial statement didn’t mention the coming bifurcation of the stock market that Bregman called the “ETF divide.”

On one side of the line are the anointed ETF constituent securities; on the other side is everything else.”

Again, the emphasis added was mine, as the impact of ETF investing has been particularly pronounced in the commodities sector, and specifically the energy sector.

The larger market capitalization companies that have dominated the energy ETF’s, notably Exxon and Chevron (CVX), have relatively flourished while most of the mid-capitalization and smaller capitalization equities have been in one of the worst energy equity bear markets in modern market history.

Thus, even relatively large exploration and production companies, like Chesapeake Energy (CHK), and Southwestern Energy (SWN), which are the second and third-largest natural gas producers in the United States, have been cast aside due, in part, to their market capitalization’s, which shrink further as they are not included in the exalted passive indexes and chosen ETFs.

Risk Is Misinterpreted

From my writing, you can already probably tell how much I enjoyed this presentation, and the corresponding write-up.

Here is another nugget, via several paragraphs about risk, specifically related to the REIT sector, think the Vanguard REIT ETF (VNQ), or the iShares U.S. Real Estate ETF (IYR), that I think will hit home for many investors.

“Now came a question: “So how do they—the big ‘they’—address this risk?”

And an answer: “In the financial realm, risk has come to be measured by historical price volatility. Consequently, enormous effort is devoted to finding low-volatility sectors with sufficient liquidity. The most prominent statistic for volatility is beta. Go to Yahoo Finance, type in ‘IBM,’ (IBM) and there, front and center alongside price, market cap and dividend yield, is beta.

“Let’s examine this,” Bregman went on. “The iShares REIT ETF (IYR), with a 2.8% yield—which I personally see as 35x earnings—has a beta of 0.72. That is low-risk by definition. But which beta should be used for that definition? The beta for the three years through August 2016? Why not the beta for the three years to March 2007?

Because the beta at the end of March 2007 was even better—an incredibly low 0.3—only 30% of the volatility of the S&P 500. By February 2009, two years later, the ETF fell 90%, and even Simon Property Group (SPG) shares fell almost 70%, while the S&P (SPY) fell about 46%.”

The problems that we had evaluating risk in 2007 are even worse today, in my opinion, as correlations are higher, and the amount of listed equities in the United States has shrunk by roughly half.

In summary, the accelerated adoption of passive investing and ETF investing has heightened risks, but investors and speculators do not realize this, because volatility in the markets has been so low, and the lack of draw-downs has provided and eerie calm and complacency that supersedes the 2007 investing landscape, in my opinion.

The Opportunity

For someone who has spent the past 25 years actively investing and speculating, but who has gone through a very rough period of performance, I can empathize with the following quote from the write-up of the conference.

“So much for life on the sunlit side of the ETF divide. What about life in the darkness? “In the past two years,” said Bregman (Author’s  Note: Remember this presentation occurred in October of 2016, but the trends have continued through today, nearly a year later), “the most outstanding mutual fund and holding-company managers of the past couple of decades, each with different styles, with limited overlap in their portfolios, collectively and simultaneously under-performed the S&P 500. We’re talking 10 to 20 percentage points in a given year. There is no precedent for this. It’s never happened before.

“It is important to understand why,” he stated. “Is it really because they invested poorly? In other words, were they the anomaly for under-performing—and is it reasonable to believe that they all lost their touch at the same time, they all got stupid together? Or was it the S&P 500 that was the anomaly for outperforming?”

From my perspective, I agree with the bulk of this commentary, with the exception of the comment about the under-performance by the best money managers.  It has happened before, and it happened fairly recently, specifically in 2007 and 2008.

During this time-frame, active managers, particularly value managers, under-performed, as traditional bastions of value, notably financial stocks, suffered the worst declines.

I can remember than time-frame clearly, and what I remember is that very few analysts and investors could value anything, similar to today.  It was confusing, and confounding, but it offered substantial opportunity, as does the investing environment today.

When valuations have no anchor, prices can fluctuate wildly.  For us, as contrarian investors, that means some of our big losers on the year, or since inception, have the potential to rapidly reverse course, but it is hard for us to realize that right now, as we have been battered by the non-stop declines, constant negative news headlines, and price action that is seemingly negative every day and every week.

Conclusion – Embrace Active Investing & Being Different Than The Indexes

Here are some quotes I highlighted in the article, directly from the presentation, which again occurred in October of 2016, but is even more relevant today, in my opinion, and I wanted to list them again, because they provide a conclusion that practically writes itself.

“He called the exchange-traded fund excrescence the world’s biggest bubble. “It has distorted clearing prices in every sort of financial asset in every corner of the globe…,” asserted Bregman. “[I]t has created a massive systemic risk to which everyone who believes they are well diversified in the conventional sense are now exposed.”

“There is no factor in the algorithm for valuation,” our speaker noted. “No analyst at the ETF organizer—or at the Pension Fund that might be investing—who is concerned about it; it’s not in the job description. There is, really, no price discovery. And if there’s no price discovery, is there really a market? In which case, what is EMHY really worth?”

This is about artificial supply-and demand pressures. Now, take this exercise and apply it to the equity indexes. That’s what’s going on. It’s just tougher to debate.”

“On one side of the line are the anointed ETF constituent securities; on the other side is everything else.”

Because the beta at the end of March 2007 was even better—an incredibly low 0.3—only 30% of the volatility of the S&P 500. By February 2009, two years later, the ETF fell 90%, and even Simon Property Group (SPG) shares fell almost 70%, while the S&P (SPY) fell about 46%.”

“It is important to understand why,” he stated. “Is it really because they invested poorly? In other words, were they the anomaly for underperforming—and is it reasonable to believe that they all lost their touch at the same time, they all got stupid together? Or was it the S&P 500 that was the anomaly for outperforming?”

From the presentation, its documentation, and my chronicling, and commentary, it should be clear that the markets have reached extremes (they had already reached these extremes in 2016 but have extended these extremes further in 2017), perhaps beyond any prior valuation extremes in modern market history.  Absolute valuations certainly rival 1999, but relative valuations between the “have’s” and the “have not’s” is even more pronounced.

The lack of price discovery, and valuation analysis, which is accelerated in a self-reinforcing cycle by the massive fund flows into passive and ETF investing, has created a market that is ripe for price discovery, which should be a dream environment for active investors.

In summary, simply surviving to get to the price discovery phase has been difficult, however the rewards should be similar in magnitude, and perhaps even greater than the 2008/2009 opportunity, which rivals any period of potential returns in modern market history.

To close, the market has a dividing line today, which is even more pronounced than 2016, and the stock market remains extremely bi-furcated.  The opportunity lies on the other side of this dividing line, in sectors, like commodity equities, which have very little weight in indexes.  Drilling down further, commodity stocks that reside outside the “halo” of wide-scale ETF ownership, offer return potential that is every bit as good as the depressed financial and real estate shares in the Spring of 2009.

Two Research Services

To get in on the ground floor of this opportunity (yes it is still a ground floor, maybe even lower after energy prices bottomed nearly three years ago in 2016), please consider one of the two following research services.

First, is The Contrarian, where we have a live history that actually captured the past significant inflection point in 2015 & 2016. Members can read through posts from that time, see how out-sized returns were achieved, look at what is similar today, and try to apply those past learning lessons to today’s market environment.

Put simply, I really appreciate our group at The Contrarian, many members who I have come to respect, and I am optimistic that we are all going to do very well together in the year ahead, similar to 2016.

We are always looking for new members that can add profitable ideas, or challenge existing ones, so if you fit this criteria, consider signing up.  A fair warning, though, our group is like the Marines, only a few, only the strong, can survive.

Second, I have had quite a few requests for a lower-priced, curated research product, a stepping stone to The Contrarian (our goal is that you try our research at a lower price, make money, and then later upgrade to The Contrarian for the more in-depth, interactive experience), and over the last several months, I have slowly put together a more traditional research newsletter.

To celebrate the second official month of this research product, where the goal is deliver one deep-dive article a month via a PDF emailed report (and I believe there are a lot of once in a generation opportunities today), I am offering a 21% discount off of a much lower annual price point. To get this limited-time discounted price, simply use the coupon code “december”.

Ultimately, I think we are now at a major inflection point in the financial markets, highlighted by the price action in October of 2018, and November of 2018, which has been ongoing in slow motion for three years, but which could suddenly accelerate. Being different, being contrarian, has been extremely painful for over two years now, however, resilience and persistence, two necessary qualities for success in contrarian investing and in life in general, in my opinion, are leading to what I believe is an upcoming golden age for active investors.

If you have any questions, send me a direct message at any time,

Travis

P.S. I have learned over my career that handling disappointment, and taking advantage of the resulting opportunity is a crucial skill for investors and speculators.  I cannot tell you how often I am disappointed in the investment markets with price action, yet stubbornness, persistence, and hard work often, but not always, result in a favorable situation, like most things in life.

P.S. II With everyone looking for a price dislocation similar to 2007-2009, look for something different to happen, including a potential pick up in inflation and interest rates, which very few are even considering.