If everybody indexed, the only word you could use is chaos, catastrophe… The markets would fail.”
– John Bogle, May 2017
Try to buy assets at a discount rather than earnings. Earnings can change dramatically in a short time. Usually, assets change slowly. One has to know much more about a company if one buys earnings.”
– Walter Schloss
A 60:40 allocation to passive long-only equities and bonds has been a great proposition for the last 35 years… We are profoundly worried that this could be a risky allocation over the next 10.”
– Sanford C. Bernstein & Company Analysts (January 2017)
Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria.”
– Sir John Templeton
Life and investing are long ballgames.”
– Julian Robertson
Even if you have the best fishing gear, if you are fishing in the wrong pond, you are going to have a bad outcome.
– WTK, December 2020
My favorite direct hedge fund investment has been Maverick Capital, the hedge fund founded by Lee Ainslie with an initial investment of $38 million from Texas entrepreneur Sam Wyly in 1993.
For starters, I like the name, and more importantly, I like the active investment approach that has always focused on picking stocks within a sector to outperform or underperform.
When I visited Maverick’s offices from 2005-2009, they were undergoing a serious test, specifically what transpired in the fall of 2008, which was a dramatic market decline, that particularly impacted Maverick’s leveraged fund.
Sticking to their knitting ended up paying tremendous dividends, however, there was a real cost to this approach too, as many investors got a real time check-up of how much volatility they could tolerate.
Building on this narrative, as many reading this opening introduction know, I’m a market generalist, agnostic to the stocks and sectors I follow as an analyst, and I will follow whatever sector is the most appealing from a risk/reward standpoint.
Over the past several years, the sector that has caught my eye the most, to a degree even greater than precious metals equities caught my eye from 2000-2010, is the energy sector.
True to form, there has been very wide dispersion among energy equities in 2020, so as an analyst, if you could pick the winners and losers, the set-up has been in place for a banner year, and we certainly have had one at The Contrarian. Not resting on our accolades earned, the focus on who will be the winners and losers in what is shaping up to be a potential secular bull market in the energy sector is crucially important at this juncture.
A Wide Dispersion In The Energy Sector In 2020
The best way to show how wide the dispersion has been in 2020 is to use the following table that I created on Oct. 4, 2020 for our group, that showed the top independent exploration and production companies in the U.S., ranked by their production in the table below, behind Exxon Mobil (XOM) and Chevron (CVX).
Looking at the table above, these exploration and production companies are listed in the same order below along with their year-to-date 2020 returns, inclusive of XOM and CVX, which are the two largest producers, and removing the acquired and restructured companies.
- Exxon Mobil – Shares Are Down 35.4% YTD
- Chevron – Shares Are Down 24.5% YTD
- Occidental Petroleum (OXY) – Shares Are Down 55.2% YTD
- ConocoPhillips (COP) – Shares Are Down 35.2% YTD
- EOG Resources – Shares Are Down 38.4% YTD
- EQT Corp. (EQT) – Shares Are Up 30.9% YTD
- Antero Resources (AR) – Shares Are Up 104.6% YTD
- Ovintiv (OVV) – Shares Are Down 33.1% YTD
- Devon Energy (DVN) – Shares Are Down 32.3% YTD
- Cabot Oil & Gas (COG) – Shares Are Up 0.9% YTD
- Apache Corp (APA) – Shares Are Down 36.0% YTD
- Marathon Oil (MRO) – Shares Are Down 49.3% YTD
- Pioneer Natural Resources (PXD) – Shares Are Down 23.8% YTD
- Southwestern Energy (SWN) – Shares Are Up 48.8% YTD
- Range Resources (RRC) – Shares Are Up 51.8% YTD
- Continental Resources (CLR) – Shares Are Down 50.6% YTD
- Concho Resources (CXO) – Shares Are Down 32.4% YTD
- Hess Corporation (HES) – Shares Are Down 17.0% YTD
- Diamondback Energy (FANG) – Shares Are Down 46.7% YTD
- Cimarex Energy (XEC) – Shares Are Down 25.0% YTD
- WPX Energy (WPX) – Shares Are Down 41.3% YTD
- CNX Resources (CNX) – Shares Are Up 33.3% YTD
In performing a similar year-to-date performance exercise when I authored this article on Antero Resources, I had pointed out how the Appalachia-focused, core Marcellus energy equities had outperformed, and that outperformance has actually continued over the past several weeks. Said another way, momentum is begetting momentum, which is a hallmark characteristic of the equity markets that we find ourselves in today.
The Structure Of The Market Is Now A Tailwind For The Outperformers
In an Aug. 13, 2019 member article titled, “Defending Antero & Refuting The Bearish Case On Natural Gas,” I defended Antero Resources when many analysts were claiming that it was the weakest of the Appalachia focused natural gas equities. Since that time frame, Antero has been the strongest performer, validating what we saw from an analyst standpoint when few others could see through the fog of price action and the market structure.
Specific to the market structure, I wrote this privately for members in the above article back in August of 2019.
The bearish case, which is a hedged-bear case (more dangerous than it sounds), since the analyst is suggesting a short of Antero as a hedge against a long energy basket, basically parrots what Matthew Smith of Deep Basin Capital articulated at the May 6, 2019, Sohn New York Investment Conference. This conference featured a line-up of speakers, some famous, including David Einhorn, who made a short-case against Tesla (TSLA) (that call turned out terribly), Larry Robbins, who most notable pick was to short 3M (MMM), and Jeffrey Gundlach, who recommended investors buy interest rate volatility, which was a good trade with the benefit of hindsight.
Deep Basin Capital, which has substantial seed backing from investment heavyweights, including Citadel, is a perfect example of what has happened to the active stock picking business (it also explains why there is so much opportunity today), as traditional valuation analysis has been edged out, by a supposedly more sophisticated long/short approach.
That long/short approach that prevailed at the end of 2019 in the energy space was long the previous outperformers like Cabot, and short the previous underperformers like Antero. However, with Antero shares up 104.6% in 2020 YTD, and Cabot shares higher by only 0.9%, the long/short trade here is not working, forcing those short shares to finally cover. On this note, even with the tremendous rally in 2020, Antero still has more than 20% of its outstanding shares sold short. This position will eventually have to be covered, providing a catalyst for further upside potential in Antero Resources shares.
Adding to the narrative, a popular long/short energy play the last several years has been to be long the Permian producers and short the Appalachia producers, based on thesis that associated gas production and associated natural gas liquids production from the Permian would exhibit a gravitational pull lower on dry natural gas pricing, and natural gas liquids pricing.
Again, this has not played out in 2020, and it was really not playing out all the way back to the first quarter of 2019, with the exact opposite scenario happening, catching many of the long/short investors on the wrong side of the trade.
Closing Thoughts – The Structure Of The Market Is Extremely Important and It Now Has Become A Tailwind
Individual investors should have the advantage in the stock market, as we are not forced to buy or sell at price insensitive or valuation insensitive prices. We can wait for Mr. Market to offer extraordinary bargains, and we can sell to Mr. Market when he is paying exorbitant prices. In theory, this sounds easy, however, in practice it is much more difficult.
The difficultly is amplified by the structure of the markets today where momentum is prized above almost any other attribute, which is enhanced the sheer fund flows into price insensitive and valuation insensitive passive strategies. Thus, when relative strength is against you, good luck getting the tires spinning, as this headwind of the market structure is effectively the same as a deep layer of mud, where traction is very difficult to gain.
On the other hand, when relative strength is behind you, a lot of gravitational fundamentals can be overlooked, even if this is temporary. The ideal situation, of course, is when you have both momentum and positive fundamentals, and that is what we have in the core Appalachia natural gas producers today, including Antero Resources, Southwestern Energy, Range Resources, CNX Resources, and EQT Corporation.
In contrast, many of the most highly touted energy names on Seeking Alpha are struggling. This includes large-cap favorites like Exxon Mobil, which I remain bullish on, whose shares have declined 35.4% year-to-date, industry favorites like EOG Resources, whose shares are down 38.4% YTD, mid-cap favorite stocks like Cenovus Energy (CVE), which I remain bullish on too, whose shares are down 41.1% YTD, and previous dividend favorites like Vermilion Energy (VET), with VET shares down 71.2% in 2020
In summary, while I fully expect a forthcoming tailwind to benefit almost the entire surviving list of companies in the energy sector, with some of the laggards potentially positioned to move up the most, dispersion is going to continue to be very wide, offering tremendous opportunity for active stock pickers. Moving the focus from the sector level to the broader market, the same opportunity, meaning the wide dispersion, is going to be present in the broader equity market, so active stock picking is going to be crucial, in my opinion.
We have seen this first hand at The Contrarian in 2020, with our options focused Bet The Farm Model Portfolio up 164.6% year-to-date through Dec. 18, 2020, outpacing the 16.9% return in the SPDR S&P 500 ETF over this time frame. If options are not your cup of tea, which should be true for most investors, our Best Ideas Model Portfolio is higher by 48.3% YTD through Dec. 18, 2020, again outpacing the 16.9% return of the SPDR S&P 500 ETF over this time frame. Even our Stuck On Yield Model Portfolio, which as the name implies, focuses on yield oriented stocks, is positive since its Feb. 21, 2020 launch, no small feat given that many yield-oriented stocks have been decimated by cuts in their dividends as the COVID-19 pandemic spread aggressively.
Building on this narrative of the importance of stock picking, this earlier example in this compare and contrast article from February of 2020, comparing Antero Midstream (AM) to Energy Transfer (ET), showed the difference stock picking within a sector can make, with AM shares up 39.7% in 2020, and ET shares down 41.9% as of this writing. Having said that, there should be a broad tailwind for commodities, and commodity equities, not the headwind we saw for most of the past decade. On this note, we are poised for a very similar comparative return environment to the one we saw from 2000-2010. Being early has been painful, however, we are starting to really turn the corner, as these member comments highlight.
Bigger picture, investors need to think differently about portfolio construction considering commodities and commodity equities as a reflationary environment is upon us, not a disinflationary one. Said another way, what has worked in the past, notably a traditional 60/40 portfolio, which has excelled over the past decade, is unlikely to work going forward. When we look back to this investment environment, I think that market participants in the future will say the removal of Exxon Mobil from the Dow Jones Industrial Average marked a historic inflection point.
There is historic opportunity in the investment markets today. I have spent thousands of hours analyzing the markets, looking for the best opportunities, looking to replicate what I have been able to accomplish in the past. From my perspective, the opportunities in targeted out-of-favor equities today are every bit as big as the best opportunities in early 2016, and late 2008/early 2009. For further perspective on these opportunities, consider a membership to The Contrarian, sign up here to join.
Disclosure: I am/we are long AM, AR, CNX, COG, CVE, CVX, DVN, EQT, ET, OVV, OXY, RRC, SWN, AND XOM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Every investor’s situation is different. Positions can change at any time without warning. Please do your own due diligence and consult with your financial advisor, if you have one, before making any investment decisions. The author is not acting in an investment adviser capacity. The author’s opinions expressed herein address only select aspects of potential investment in securities of the companies mentioned and cannot be a substitute for comprehensive investment analysis. The author recommends that potential and existing investors conduct thorough investment research of their own, including a detailed review of the companies’ SEC filings. Any opinions or estimates constitute the author’s best judgment as of the date of publication and are subject to change without notice.