The prominent technology investor Peter Thiel starts his new book, “Zero to One,” by posing the question, “What important truth do very few people agree with you on?” This is his standard question when interviewing potential employees.
For most, it’s a difficult question. An easier way to provide an answer may be to ask what most people already agree on and then rigorously determine if it may be a popular delusional belief. Often, a good answer will stimulate ideas for a successful new company.
Many ETF strategists (including this author) follow a similar discipline, relying on “nonconsensus” global macro views to drive alpha-generating portfolio ideas. For us, success is the development of a macro argument—not shared by the majority—that actually comes to define the future. Often, the ETF position resulting from that thesis may not be so obvious. For example, our current view on oil leads us to the iShares MSCI India ETF (INDA | C-91).
To be sure, this is not necessarily “contrarian investing.” Rather, our firm’s default portfolio position is the passive index, unless a controversial idea can be constructed. That is important. It means the bar remains high for active positions. After all, we are still Bogle’s tribespeople, heeding his admonitions of overtrading (even if our macro tendencies would leave him thunderstruck).
Lower For Longer
Looking ahead to 2015 and beyond, a central macro question is the direction of global oil prices. Next to the Fed funds rate, this is the single most important number for world markets.
In recent months, most remain attached to the notion that the equilibrium price for oil is much higher than it is now.
We disagree. In fact, $50 per barrel or even lower is more likely a ceiling than a floor, and prices could remain suppressed for several years.
Three reasons are supportive of the above. First, commodities are long-trending markets. If past is prologue, it would be extremely rare to have a short-lived decline. Prices tend to rise and fall at regular decade-plus intervals. Why should the cyclical rhythm speed up now?
The law of excess also applies to commodity markets. Fact becomes blurred with fantasy. And Wall Street conforms to the unwritten rule that decent investment ideas should be drilled into the public consciousness until everyone with a pulse can recite the narrative with poetic ease.
Marketers also claim to disclose every conceivable downside risk (except, perhaps, for the endogenous consideration that the market has collectively lost its mind). Near the end of the boom, all things seem possible.
True to form, “peak oil,” “supercycles” and other Malthusian prophecies gained a record number of followers during the recent oil run-up. Yet what is now clear is that the oil and gas sector—which has recently accounted for roughly a third of S&P 500 capital spending—has been a black hole of capital misallocation.
The industry went deep into the malinvestment phase, spilling billions of dollars into unproductive ventures. Those dollars are now swimming in frantic retreat.
Secondly, country and regional dynamics of the global oil market have changed. Saudi Arabia will continue to pump at maximum output, whether for geopolitical reasons or to eliminate competitive threats from shale oil. That leaves the U.S. and other marginal operators as the new swing producers, who will reduce output during periods of excess supply. That means prices will remain under pressure until supply is significantly curtailed. Given that most U.S. shale producers are only talking of a “slowdown” rather than major supply reductions, the oil price will have to fall further until output declines sharply. We are not there yet.
And finally, investor sentiment is still wildly bullish. This can be measured via flows into ETFs (the four largest U.S.-listed oil exchange-traded products had net inflows of $1.23 billion in December alone, the most since May 2010), futures positioning (huge net long exposures in both WTI and Brent) or even the steep contango (oil for six-month delivery is still much more expensive than spot). Renewed bull markets simply don’t lift off from these levels of investor psychology.