The Solar Share Price Eclipse

When looking for clues as to market trends it is always useful to examine share price. This can often be your first clue as to emerging paradigm shifts or just health of a particular industry in general. In the case of energy, some interesting paradigm shifts are occurring which seem to be flying under the radar at present. For instance, a quick look at the share price of oil and gas companies, particularly those engaged in the self styled “shale revolution” to those engaged in competing energy activities such as solar, is eye opening to say the least.

If you are an investor, positive returns on portfolio assets are important to your future wealth. If you’re running a company, share price becomes critical because it can affect different metrics. An upward trajectory in your share price, for instance, can beneficially impact your company’s ability to tap into the capital markets to raise more money for future growth. This can be crucial in an industry like shale extraction which has significant capital requirements. Shale wells, whether gas or tight oil, are very expensive to drill and complete.

In addition, there are more layers. Markets are considered leading indicators. This means that patterns which emerge in share prices can indicate an underlying, but not necessarily obvious, pattern in the broader economy. Though it is often obscure at first, the markets can be pointing to a potential new trend. That is why it is so important to examine share pricing and make comparisons within a particular industry or within competing industries.

The shale revolution has been characterized by a frenzy of drilling for dry gas, liquids and tight oil. While the industry has indeed produced large quantities of gas and oil, its business model is questionable over the long term. Shale operators have relied on massive amounts of cheap debt to finance their activities though the wells themselves are not proving to be the energy panacea industry purports. This has been confirmed by many independent entities but most recently by the University of Texas which states that shale potential has been considerably overstated. Tad Patzek, head of University of Texas at Austin’s department of Petroleum and Geosystems Engineering, spoke with the science journal Nature. Patzek was quoted as follows:

“‘The results [of our study] are “bad news”… With companies trying to extract shale gas as fast as possible and export significant quantities… “we’re setting ourselves up for a major fiasco'”.

Equally significant is the reaction of the stock market to these shale operations.

Examining share prices of companies engaged in shale extraction over the past two years, it quickly becomes apparent that investors don’t see great potential in shales. Given its self promoted image of being revolutionary, this should have translated into share price returns that are above average. Taking five companies which are considered the darlings of the shale industry, Continental Resources, Chesapeake Energy, EOG, Range Resources and Cabot Oil and Gas, the best performer was EOG racking up 50.32% in gains over the past two years. While this may sound like a reasonable return, it pales in comparison with its solar competition. Further, EOG’s oil and gas peers fared much worse. Continental, for instance gained a mere 15.67%, Chesapeake 10.46%, Cabot -4.2% and Range a dismal -25.97. This is not revolutionary performance.

Interestingly, companies engaged in solar generation have share performance figures that are significantly better. Solar City, Canadian Solar, Jinko Solar, Trina Solar and SunPower have amassed returns ranging from 132.89% to 588.47% over the same time frame. The worst solar performance is double the best oil and gas performance. The best solar performance is ten times better than the best oil and gas performer.

But perhaps most importantly, a trend is emerging with regard to how the markets view the future prospects of oil and gas against that of solar. In other words, the markets appear to be telling us that there is no comparison. Solar has more future potential than oil and gas. Moreover, this same pattern of underperformance in these large independent oil and gas producers is also occurring in the Majors. Companies like Exxon Mobil and Shell have provided mediocre returns compared with the Dow. These same companies used to be the leaders of the Dow. Now they are the laggards.

A new energy paradigm appears to be emerging. Investors have unambiguously voted with their dollars and solar was the clear winner. Perhaps this isn’t turning out to be a shale revolution so much as a solar eclipse.

The Con of Passive Management

The passive management industry has done an incredible job of projecting their mantra into the investing zeitgeist, and each year we are subjected to claims like “74% of active managers underperformed their index.” Like all good cons, this is not an untrue statement. It is however, an excellent use of misdirection – making implications about passive strategies that are untrue.

“If that many active managers underperform, I guess I’ll just go passive.” This is the inference that the passive industry seeks from the world, and sadly one that the uncritical investor has fallen prey to. The following is not a rejection of passive strategies, but a few thoughts on how to more accurately consider the active vs. passive debate.

Let’s start with an obvious point. It may be the case that 74% of active managers underperform their index in a given year, but what is left unsaid is that if all passive managers are doing their best to follow their investment policy, 100% of them will underperform! Why? Investment strategy returns can be reduced to a reasonably simple equation:

Strategy Return = Market Exposure + Alpha – Fees

So if your alpha is 0% (all passive strategies), and your fees are > $0 (all businesses), then your returns are lower than what pure market exposure would produce. 100% of passive strategies should underperform their indices. 74% isn’t great, but it’s better than 100%.

OVERSIMPLIFIED

Passive managers are well aware that active managers’ returns are a product of their market exposure (Beta), and their skill (Alpha). The fact that the passive industry continues with the ruse of comparing all active managers to a non-risk-adjusted performance figure is deplorable, because it confuses most investors.

Most active managers run less risky portfolios than their index or benchmark. Asset management is risk management, and prudent risk reduction should not be penalized. When sophisticated investors compare managers, they compare risk-adjusted returns. The only way we should be determining an active manager’s value is by measuring alpha generation.

ZERO SUM GAME

Alpha does not exist in nature. If alpha is created in one manager’s portfolio, it necessarily means that another manager has generated negative alpha. Picking the manager that can generate long-term alpha isn’t a trivial exercise, but it is certainly worth the effort considering the impact that the power of compounding over decades has. Even if there is no alpha on average, there are many managers who generate it.

You wouldn’t stop watching the NFL and say, “Another terrible year, on average the league was just.500, again.”

So when is an active manager worthy? Don’t compare returns to an index, compare alpha to expenses. If an active manager generates more alpha than they charge in fees, they are worthwhile. In fact, it is a little easier than that, because the next best alternative to a good manager, indexing, has some costs. So a manager is worthwhile in practice as long as their alpha, less their expenses, is greater than the -10bps associated with passive management fees.

Tips for Avoiding Investment Fraud

Investment scams can take many forms, but the most common securities frauds tend to fall into the following general schemes:

Pyramid Schemes: Where fraudsters claim that they can turn a small investment into large profits within a short period of time, but in reality, participants make money solely by recruiting new participants into the program. Pyramid schemes eventually fall apart when it becomes impossible to recruit new participants.
Ponzi Schemes: Where a central fraudster collects money from new investors and uses it to pay purported returns to earlier-stage investors rather than investing the money as promised. Ponzi schemes tend to collapse when the fraudster can no longer attract new investors or when too many investors attempt to get their money out.
Pump-and-Dump: Where a fraudster deliberately buys shares of a very low-priced stock of a small, thinly traded company and then spreads false information to drum up interest in the stock and increase its share price. The fraudster then dumps his shares at the high price and vanishes, leaving many people with worthless shares of stock.
Advance Fee Fraud: These scams generally begin with an offer to pay you an enticingly high price for worthless stock in your portfolio. To take the deal, you must send a fee in advance to pay for the service, but then you never see your money again.
Offshore Scams: These scams originate in another country and target U.S. investors. Offshore scams can take a variety of forms, including those listed above. Unfortunately, whatever form an offshore scam takes, it can be difficult for U.S. law enforcement agencies to investigate fraud or rectify harm to investors when the fraudster acted from outside the country.

Red Flags of Fraud

To avoid being drawn into a scam, look for these warning signs:

Guarantees: Be suspect of anyone who guarantees that an investment will perform a certain way.
Unregistered products: Many investment scams involve unlicensed individuals selling unregistered securities.
Overly consistent returns: Any investment that consistently goes up month after month, or that provides remarkably steady returns regardless of market conditions, should raise suspicions. Even the most stable investments have hiccups once in a while.
Complex strategies: Legitimate professionals should be able to clearly explain what they are doing. It’s critical that you understand any investment you’re considering.
Missing documentation: If someone tries to sell you a security with no documentation, he or she may be selling unregistered securities.
Account discrepancies: Keep an eye on your account statements to make sure account activity is consistent with your instructions and be sure you know who holds your assets. Fraud can more easily occur if the advisor is the custodian of the assets and keeper of the accounts.
A pushy salesperson: No reputable investment professional should push you to make an immediate decision about an investment, or tell you that you’ve got to “act now.”

If you’re able to identify red flags of investment frauds and you know some of the most common types, you’ll be better equipped to avoid these types of scams and protect your financial future.

How to Improve Your Chances of Investing Successfully

Investing successfully can be a daunting task for individual investors. There are many factors that make investing today more difficult today than it was in times past, like the amount of available options and the amount of information available about those options. It seems as though each news cycle produces a new hot stock, ETF, or mutual fund to follow while discarding the old, tired ones in the same cycle.

This sort of media production makes investing for the long term seem outdated. However, long-term investing still offers potential rewards for those who can block out the volume of investment information that comes their way. This article presents possible ways to improve your ability to achieve investment success.

1. Block out the media noise. No offense to them, but media outlets are businesses first and foremost. Magazines and newspapers need circulation, and television shows need ratings. How many times have you seen articles about stocks to hold for the next 30 years? If an investment show or magazine provided such a list, you would have no need to subscribe or watch the show after you learned what stocks were on it.

Now, what if magazines and televisions shows told you that long-term trading was dead and that they offered some very good stocks each day, week, or month that you could trade? Do you think you would tune in more frequently or keep your magazine subscription? I am not saying that none of the information offered by the shows and magazines is good. I am saying that it is not suitable for those who wish to succeed at investing long term. Daily and weekly fluctuations in a security’s price should have no effect on a long-term investor’s perspective. That’s the stuff of day traders and swing traders. It is best to leave it for them.

2. Clearly lay out your long-term goals. Determine where you want to be financially and what you are trying to achieve. Let every investment decision be based on whether it will increase the likelihood of reaching your long-term objectives. Literally ask yourself, “Does this investment have the potential to move me toward my financial goal, or does it unduly jeopardize my chances?” If you cannot answer affirmatively with certainty, then, move on to the next security or make no move at all.

3. Do not chase after returns. Hot stocks come and go, but a well-designed plan that suits you can remain for the long haul. For long-term investors, slow and steady often wins the race. Stick to your very clear plan and do not deviate from it without good reason (Remember: Short-term gains are never good reasons to change your long-term plan). If you cannot resist trading for gain, set up a separate small account that has no impact on your long-term investing.

4. Be mentally prepared for market corrections and crashes along the way. The best time to prepare for critical periods in the market is when the going is easy. If you purchased ETFs and mutual funds at great values when the market and prices were soaring, would not those same offerings have great value when the entire market and prices were down? It seems counterintuitive, but downturns are frequently not the time to panic. They can often be the time to grit your teeth and catch the sale prices that you see all around you.

5. Avoid trying to time the market. What may appear to be a top or bottom could evaporate in the blink of an eye and leave you with huge losses or opportunities missed. Let’s assume, though, that you somehow caught lightning in the bottle and timed the market exactly right. Your money is now sidelined. Now, you have to be right about your re-entry point. Do you like your odds of being exactly right two times? The risk really is not worth the reward.

6. Consider working with a financial advisor who can help to keep you level-headed and steadfast to the plan during the market’s inevitable ups and downs. A professional may be able to become a buffer between you and your long-term investment account. He or she may be able to keep you off the investing ledge, so to speak, when you have emotional urges to sell everything during downturns or to go on a buying frenzy when you hear about some great offering that is blowing through new highs each day. Basically, the right advisor may keep you from blowing up your long-term account.

Let’s be clear: Being a long-term investor today seems more difficult than it was it times past. Even a casual observer would note that the current market seems to be more volatile than it used to be. Every week, news media seem to scream loudly about the next big things to invest in and about the dogs of the market to avoid or sell. It can all be maddening.

Of course, none of these steps will actually guarantee that you will succeed at achieving your financial goals. Investing in securities involves risk of loss. Investors should always perform careful examination of any investment offering.

Keeping an Eye on Interest Rates

The Federal Reserve and the monetary policy it pursues is always a matter of interest to investors. The level of intrigue has been particularly acute this year because of growing speculation that the Fed is likely to boost the Fed Funds rate, a short-term interest rate it controls directly, for the first time since 2006.

This creates challenges for investors who may have pursued one investment strategy in a period of declining or stable rates. A different approach might be required if the interest rate environment shifts to one where rates trend higher.

Assessing bond market risk today

Interest rate risk is always a concern for bond investors, but especially when rates are as low as they are today. Rising rates may seem beneficial to fixed income investors who would like to earn higher yields on their savings, but there is a downside. When interest rates rise, the value of bonds already in the market (and potentially held in your portfolio or bond mutual fund) declines. These price declines occur as the bond yields rise to reflect the increase in interest rates. In the long run, the bonds will mature at par, or 100% of their initial value, but in the short run, investors may see a drop in investment values.

For several years, there’s been significant speculation among market analysts that the interest rate environment was due for a change. Consider it from an historical perspective using the yield on the 10-year U.S. Treasury note at constant maturity as a benchmark:

· The yield peaked at 15.84 percent in September 1981.

· Over the next 30 years, yields moved lower, eventually hitting a low of 1.43 percent in July, 2012.

· For the last three years, yields have fluctuated in a fairly wide range, from 1.68 percent to 3.04 percent as investors have digested economic data and Federal Reserve commentaries.

At these current low levels, the general consensus is that rates are likely to move higher, meaning bond portfolios might be at risk of losing value in the near term.

A potential residual effect on stocks

The impact of rising rates on the equity market is typically less direct than it is on the bond market. At times in the past when interest rates have moved higher, it has dampened returns in the stock market. There could be a few reasons for this. With rates moving higher, some investors think bonds are more attractive than stocks. Also, higher rates could potentially dampen borrowing activity, and even contribute to a slowdown in business activity. Of course, there are many other factors that can also affect stocks and businesses besides interest rate movements. Regardless of what happens with rates, your age and investment time horizon have a lot to do with how you make investment decisions. Make sure these decisions are in the long-term interests of achieving your financial objectives.

Positioning for a change

If past market cycles are any guide, it is inevitable that at some point, interest rates will begin to move higher. The biggest questions are when it will start, and how quickly and dramatic the increase will be. While it may not be possible to eliminate all risk from the impact of rising rates, investors should exercise some caution. Now is a good time to consult with a financial professional about how to prepare for potential changes in the investment landscape that would occur if interest rates begin to move higher.