Monday, August 17, 2015

Following the money!

Long time readers of our Monday morning posts know that we often use our lists of top scoring Behavioral funds to identify trends; sometimes looking at the top 25 for a coincidental indicator and sometimes looking for patterns.

After a difficult year where energy stocks have steadily lost ground while the broader markets have held their own, it’s hardly surprising that the sector is noticeably absent from the top 100 with only two energy funds making the list.  But the market has a way of surprising you - with the Energy Sector Select SPDR (XLE) outperforming the S&P 500 for the first time in almost two months as problems at the largest oil refinery in the Midwest has sent gas prices surging.  And while that has offered succor to refining stocks, the love was felt throughout the energy sector as even natural gas and MLP funds enjoyed a strong week of outperformance.  Since we’re knee deep in 13F filings we’re going to check in on that most favored of indicators, the smart money, and see how they’re invested but whether you use it as a coincidental or contrarian signal is entirely a matter of debate.

Making the biggest splash this quarter was Berkshire Hathaway where the announcement of their acquisition of Precision Castparts nearly obscured that company has closed out most of its remaining positions in the energy sector after several quarters of trimming by selling its remaining shares of National Oilwell Varco (NOV) and Phillips 66 (PSX).  While NOV closed down slightly for the week, PSX found some buyers who were okay with diving in Warren Buffets dumpster as the stock rose over 4% last week.  With energy stocks now making up just 6% of the Berkshire portfolio, Warren Buffet finds himself in good company according to the 13F data.  Paulson & Company, Metropolitan Capital Advisors and Soros Fund Management all have energy allocations in the mid-single digits while the most watched 13F that of Appaloosa Management shows no energy sector exposure at all. Most of the smart money has instead allocated capital for merger mania with Perrigo and Mylan making the list for most popular new or expanded holdings.  Even among the top performing energy names last week, like Williams Company (WMB), Baker Huges (BHI) and EOG Resources (EOG), there was a steady trend over the quarter of money managers trimming positions in the stocks.

So if the smart money is busy chasing pharmaceuticals, who snapped up energy stocks early last week?  There was a clear trend last week of smaller energy names with higher debt-to-equity ratios outperforming, a common smart money tactic to use financial leverage to their advantage but one overlooked group might be looking at the second for another reason.  To abuse one of John F. Kennedy’s most famous utterances, investors might be coming back to the energy sector not because P/E ratios are low but instead BECAUSE they’re high.  So why are some investors seeking out high P/E stocks?  Because they remember the wisdom of investment gurus like Peter Lynch who advised investors to look at cyclical stocks on the basis of a normalized P/E ratio that encompassed an entire business cycle rather than just the trailing twelve months.  Using the ETFG Quant tables, energy funds might appear cheap when looking at three of the metrics we use including the P/B, P/CF or historic yield but they also seemingly trade at record P/E ratios as well with both the Vanguard Energy Index Fund (VDE) and XLE trading above the 4th percentile which is hardly surprising given XLE has seen its price drop nearly 30% since the recent high on 6/24/14 through last Friday while earnings are down more than 50% in the same period.

Focusing in one specific stocks, start by considering the historical P/Es for sector titan Exxon Mobil (XOM) which coming out of the great tech collapse in the early 2000s saw the stock hit a high trailing P/E of 26.32 at the start of July 2002.  While the company underperformed the S&P 500 for the rest of 2002, it marked the low-point for the stock as Exxon outperformed the S&P 500 every year for the next six years during the great commodities super cycle.   A more recent example for Exxon was the stock hitting a post-Lehman high P/E ratio at the start of 2010 around 17.7 and while the company underperformed slightly in 2010, it outperformed the market again from 2011 to 2012 by 900 bps until losing momentum as the P/E ratio began to rise as investors started to over pay for the stock.  The return patterns around cyclical stocks are rarely ever neat and clean, there does seem to be some validity to the idea that investors should be looking to buy when P/E multiples are close to highs.  And while one week does not a trend make, it seems that some investors are staking out their claims on energy stocks.

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