Oil’s fall not priced into all sectors
Housing, other amenities still peaking
Things are surprisingly quite well in Alberta, despite oil losing more than half of its value in the past few months.
Housing prices are still setting new highs, even in the luxury market; new skyscrapers are being built; cars are jamming up roads just to get into shopping mall parking lots; there are waiting lists for new luxury vehicles; pricey private schools are once again near capacity; and there are few deals to be had among airlines and hotels due to the very robust demand for travel.
A common response when surveying the marketplace is that the broader equity market in the U.S. is at record highs, so the recent weakness in oil prices is likely only temporary. However, being contrarians, we wonder what happens when consumers suddenly wake up and smell the bitumen?
Interestingly, the faster the drop in oil, the quicker the recovery, as pointed out by oilpatch veteran Jim Gray in a recent Calgary Herald interview. But the current correction is showing little signs of bot-
It’s an excellent time to rebalance one’s portfolio
toming and is now 195 days in length, which is the longest over the past 15 years.
This trend isn’t encouraging as oil prices have already fallen 52%, the second-largest drop over the same period.
There are clearly some risks on the horizon once this starts to sink in, especially for Albertans. Perhaps the catalyst will be an acceleration of job cuts early in the New Year as companies realize that oil prices may take some time yet to recover.
For investors, there will likely be continued volatility in the oil and gas sector, which lost 16.4% of its value last year and is off nearly 40% from its highs.
For those looking to add positions, it’s important to average in and target only those companies able to survive a prolonged downturn. Look for robust balance sheets and management teams with a proven track record of handling risks by using tactics such as hedging in the past.
The good news is that many of these companies are now trading at 2008 financial crisis levels, so there are some excellent value opportunities out there for patient, long-term investors willing to ride out the current storm.
That said, we are worried about the level of complacency in other sectors as investors continue to shrug off any potential impact from weaker commodity prices.
The Canadian banking sector, for example, is factoring in a similar earnings growth rate to last year, when the financial services index posted a 10.5% total return. What happens if there is a material slowdown in the red-hot western Canadian housing market?
Additionally, a lot of the banks’ capital market business last year was generated in the first half from a record-setting IPO market, secondary market and M&A activity in energy.
Also, what about the overall consumer market in Canada? Will it not be impacted by a weaker Western Canada?
According to Western Economic Diversification Canada, Western Canada accounted for 34% of Canada’s real gross domestic product by industry and 40% of Canada’s exported goods in 2011.
Apparently, investors are not too worried: the S&P/TSX capped consumer staples index posted a whopping 48.3% total return last year.
In conclusion, we see some risks on the investment landscape horizon that are being reflected in certain sectors, but not in others.
Therefore, it’s an excellent time to rebalance one’s portfolio by taking some profit among those sectors experiencing the most complacency to minimize the fallout of a potential prolonged downturn in energy markets.