Profiting (and Losing) from Hope

Following on from my comments on oil yesterday, I read this in today’s Financial Review:

‘When OPEC and Russia first embarked on their strategy to clear a global oil glut, it was expected to succeed within six months. It now looks like the battle could last for years.

‘The Organisation of Petroleum Exporting Countries and its partners plan to wrap up their production cuts next spring, already nine months later than originally expected. Yet oil prices are faltering again as data from the International Energy Agency show world inventories could remain oversupplied even after the end of 2018. ESAI Energy LLC predicts that, rather than months, draining the surplus may take years.

‘”They’re going to have to dig in for the long haul,” Neil Atkinson, head of the IEA’s oil markets and industry division, said in a Bloomberg television interview. “Re-balancing is a stubborn process.”’

This is the consensus view in the oil market. That is, there is a global glut that not even the powers of OPEC can clear. Given this view, who would want to buy oil or energy stocks?

That’s right, no one.

Or very few investors, anyway. Most fund managers are underweight oil and energy. The fundamentals look terrible. But looks can be deceiving…

When you read articles like this, you tend to process it quickly and file oil under the heading, ‘don’t buy now or anytime soon’.

That’s what most people do, anyway.

Which is how buying opportunities emerge. As I said yesterday, find the false premise and bet against it. In an upcoming report (keep your eye out for it next week) I explain what the false premise in oil is, in detail.

Check the Facts

But for now, let’s check on the facts. The article above says, ‘yet oil prices are faltering again.’ Really?

To me, it looks like oil is attempting to form a bottom. Let’s have a look at the chart of Brent crude…

Source: Optuma
[Click to enlarge]

The price hit a capitulation low in January 2016. It rebounded sharply and then started to move in a sideways range.

One point to note is that since May 2016, oil has found support around US$44 a barrel. It only dipped briefly below that point during the Brexit panic sell-off.

In late 2016, Brent broke out to a new high, but then sold off, again finding support around US$44. This appears to be the point where oil traders know that OPEC will support prices, and there is no use selling oil below here.

Let’s call it the US$44 floor.

If this is true, then downside from here is limited. But if Brent goes on to make a ‘higher low’ in the weeks to come (somewhere above US$44 a barrel) I think it is only a matter of time before oil breaks out to new highs.

This is not just wishful thinking. There is some detailed analysis behind this call. As I mentioned, keep an eye out for my report on this next week.

Elsewhere, did you see the reaction to earnings result from Domino’s Pizza [ASX:DMP] yesterday?

It wasn’t pretty.

Despite posting earnings growth of nearly 30%, the share price fell nearly 20%. Check out the share price chart…

[Click to enlarge]

This is what happens when you’re dealing with an expensive stock. The slightly weaker than expected earnings and reduced expectations for next year do not go down well when investors expect the best.

Or did they?

The true believers may have expected something better from DMP. But if you know how to read a chart, you would not have got caught up in yesterday’s mess.

Put simply, the DMP share price has been trending lower for a while now. When a trend is so noticeably to the downside, you should never buy into a stock.

The downtrend is the market’s not-so-coded message telling you that something is going on. That something is not good. The sellers are overwhelming the buyers. Investors are getting out.

Is DMP worth buying now, after such a big price decline? The stock still trades on a price-to-earnings ratio of around 25 times expected earnings for 2018. There is still a bit of hope priced in.

Regardless, with the trend still definitively down, I suggest staying away. Sure, you might get lucky and pick a short term bottom, but it’s a low probability play.

The other point to note about expensive growth stocks like Domino’s is that when they go offshore to generate growth, the risks rise exponentially. What worked in Australia won’t work exactly the same in other markets.

Domino’s is expanding in France, but growth there disappointed. It shouldn’t have. The expectations were simply too high.

It happens every reporting season. A darling growth stock gets hammered on disappointing earnings. Hope turns to disappointment.

It’s human nature to hope. The trick is to buy when there isn’t much hope around. This is why I like oil right now.

Hope then pushes prices well beyond their true worth. At which point, you need to try and keep your head, and move towards the exits.

That’s easier said than done.


Greg Canavan,
Editor, Crisis & Opportunity

Greg Canavan is a Feature Editor at Money Morning and Head of Research at Fat Tail Investment Research.

He likes to promote a seemingly weird investment philosophy based on the old adage that ‘ignorance is bliss’.

That is, investing in the Information Age means you have all the information you need at your fingertips. But how useful is this information? Much of it is noise and serves to confuse, rather than inform, investors.

And, through the process of confirmation bias, you tend to read what you already agree with. As a result, you often only think you know that you know what is going on. But, the fact is, you really don’t know. No one does. The world is far too complex to understand.

When you accept this, your newfound ignorance becomes a formidable investment weapon. That’s because you’re not a slave to your emotions and biases.

Greg puts this philosophy into action as the Editor of Crisis & Opportunity. As the name suggests, Greg sees opportunity in a crisis. To find the opportunities, he uses a process called the ‘Fusion Method’, which combines traditional valuation techniques with charting analysis.

Read correctly, a chart contains all the information you need. It contains no opinions or emotion. Combine that with traditional stock analysis and you have a robust stock-selection strategy.

With Greg’s help, you can implement a long-term wealth-building strategy into your financial planning, be better prepared for the financial challenges ahead, and stop making the basic, costly mistakes that most private investors do every time they buy a stock.

To find out more about Greg’s investing style and his financial worldview, take out a free subscription to Money Morning here.

And to discover more about Greg’s ‘ignorance is bliss’ investment strategy and the Fusion Method of investing, take out a 30-day trial to his value investing service Crisis & Opportunity here.

Official websites and financial e-letters Greg writes for:

Money Morning Australia