Making money with stocks seems easy when you’re not really thinking about it.
Oh, well Apple (AAPL) is a great company, solid revenues, good profit margin, a boatload of cash, great technology, forays into high-growth subsectors, and helmed by Tim Cook, one of the best business leaders in the world today.
Buy the stock and it’ll go up… right?
Well, that’s only half the story.
One of the great debates through the history of the stock market is why stocks move up or down in the first place. It sounds silly, but understanding this will help position you for profiting in the short-, intermediate-, and long-term. Especially with what came out of the OPEC meeting last week.
On one side, there are the fundamentalists. Think of people like Warren Buffett or hedge fund titan Bill Ackman.
A company, based on all accounting and “soft” principles – like those about Apple we just spoke about – make the company’s stock “intrinsically worth” a price. I won’t go into too much detail here, there are hundreds of books on the subject, but this is the premise of value investing. A company costs less right now than what it’s intrinsically worth, so you buy it and believe that it’ll revert to its “real” price in the future.
On the other side is the famous “beauty contest” theory, created by one of the greatest economists of all time, John Maynard Keynes, back in the 1930s.
The idea is psychological and simple - when seeing a panel of beauty pageant contestants and needing to vote on which you think is the most beautiful, what you’re measuring as beauty isn’t necessarily what you’re voting on. What you’re voting on is who you believe other people will believe is the most beautiful.
So, instead of “intrinsic worth,” a stock is worth what you believe other people believe it to be. It’s all relative.
Now, without getting into the merits and pitfalls of either one, because there’s no right or wrong (they’re both right), let’s apply these to the OPEC+ production decision last Thursday.
The delayed ensemble of oil-producing countries, Saudi Arabia, the UAE, Nigeria, Angola, and Iran, among others, came out on the other side of the meeting saying that there won’t be a concerted oil production cap mandate into next year.
In typical OPEC fashion, though, that’s not the whole story.
There’s been speculation that there wasn’t a mandate because of growing dissension in the group of late…
But individual countries have decided to impose voluntary restrictions that’ll amount to two million barrels per day early next year.
The theories about where global oil prices will go are far and wide.
But casting aside the politics, let’s focus on what we were talking about a minute ago – the beauty contest.
Large oil producers tend to cut when they think market supply is too high. And when they cut supply while demand remains the same, prices move higher.
OPEC and OPEC+ account for a third to half of all global oil production each year. So, cuts have usually been followed by price spikes.
Because people believe they should rise.
Think about it… if OPEC says they’ll create a new batch of cuts by the end of the first quarter, and the price per barrel increases by 10% (not outside the realm of possibilities), traders are acting without anything actually happening.
Case in point, after the announcement, oil prices fell a few percentage points because of the non-collective-mandate. Yet, supply and demand didn’t change overnight.
And now that dozens of analysts, Goldman Sachs included, have announced possible $100 price targets, people are going to be reacting to what they think this means for other people, too.
But the longer-term situation looks much different.
$100 a barrel (30% higher than where we are now) isn’t sustainable for a few reasons…
The U.S. election year means we’ll try to smother prices at the pump to keep the voting public happy.
Weakening demand for oil’s biggest importer, China, means less fuel and lower prices.
Dissention within OPEC means some producers won’t cap their production.
And the ever-present predictions about a recession in the U.S. would weaken demand here as well if this materializes (there are already signs of weakening consumer demand).
There are plenty of reasons why oil will average – and average is the key – around $80 rather than $100. Lower rather than higher.
And the best way to play that is to buy and hold the U.S. producers who benefit the most from oil around that price. Two names on the top of that list are Occidental Petroleum (OXY) and Exxon Mobil (XOM).