You know something odd is going on in global markets, but do you know quite how odd? Here’s a hint that the level of distortion is getting a bit too weird for comfort. In the US, the number of loss-making mid- and small-cap companies as a percentage of the total is at an all-time high (29%). We can forgive a lot of losses right now (lockdown, etc) and this number often peaks towards the end of a recession. But how’s this for nuts: investors are currently paying a premium for those loss-making companies. They’ll pay more for “no money”, than they will for “some money” (see this week's magazine for how to avoid doing the same). Then there’s this: nearly 80% of initial public offerings in the US come with what analysts like to call “negative earnings” (losses). We could fill pages with indicators such as this – reminders that bullishness is at an extreme and that, while recognising that the madness could continue for a long time, we should adjust our portfolios accordingly.
How? Find where the “prevailing narrative in the market is disjointed from the realistic trajectory for operations in the real world” – in a negative way, says Kennox Asset Management’s Charles Heenan. One example is oil and mining – where prices are finally starting to soar. Oil was back above $60 a barrel this week having effectively gone to zero last spring. So how about buying Shell, says Heenan? No one is investing in supply anymore – “it’s absolutely brutal out there”. That’s partly because prices have been low (low prices lead to falling supply). But it’s also about ESG investing (investing with an eye to environmental, social and governance issues). Big oil firms, like big miners, are not exactly top of the pops with modern institutional investors and their obsession with the optics of their newly acquired moral frameworks. That not only makes it hard for dirty commodity firms to invest in new supply, but also very costly for them to do so: new projects come with new levels of regulatory costs as well as much higher payments to communities (water management, engagement, healthcare, etc) and governments (taxes and royalties).
That’s no bad thing. But it does push up the overall cost of increasing supply. That’s a long-term problem given that fossil fuels still generate 80% of global energy and alternatives cannot yet hit the same scale. It makes little sense, notes Heenan, to vilify the firms keeping our lights on, our ambulances running, our laptops powered, our bitcoin mined (!) and our food refrigerated. Given this, the best way to take advantage of today’s ESG and clean energy enthusiasm is not to invest in the clean energy stocks everyone loves – say, Ceres Power (up 1,000% in the last two years) – but in the old energy stocks everyone still needs (Shell is down 41% in the same period).
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If that sounds interesting (and you can consider this, while also thinking that clean energy and a clear path to “net zero” is badly needed) you might also look at thermal coal, today’s ultimate contrarian investment. Value investor Andrew Hunt notes that supply is static-to-falling, but demand very much still with us. Look perhaps to Glencore in the UK for exposure. If single stock investing is not for you, note that, just as by being a passive investor in the US you are a tech investor, just by being a passive investor in the UK you are a commodities investor: energy and miners make up more than 20% of the FTSE 100 index. Perhaps after years of underperformance, the UK market might finally be coming good.
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