My journey from loyal employee to sole proprietor has changed the way I think about opportunity. As someone no longer tethered to a single W-2 (traditional job), I am learning to embrace the optionality of multiple 1099s (non-traditional job income) and the new perspective it provides. Call it better peripheral vision, and a strong desire to fund my next meal. So for everyone looking beyond 4 percent dividend returns and low cost indexing, hereʼs my investor wish list for 2016.
Oil, Oil Everywhere… For Now
I began my trading career at a 200-year old French commodities company, rising from wide-eyed intern to manager of the largest commercial jet fuel position in the country. The experience taught me an important adage: the cure for low prices is low prices. Simply put, falling price reduces incentive to produce, and lower supply leads to higher prices over time. The key word here is time, especially in light technological improvements (fracking and horizontal drilling) which have dramatically increased supply and lowered costs.
While some U.S. shale producers can now operate profitably with oil in the mid-30s, they will eventually deplete “cheap” barrels, meaning supply at lower price points will decrease. This cheap barrel overhang will last 12-18 months by most estimates, with some like Goldman Sachs calling for $20 oil near-term. Assuming global demand continues to rise 1.4 percent to 95Mb/d in 2016 (U.S. Energy Information Administration), prices will have to rise in order to bring marginally less profitable barrels to market. Maybe this occurs mid-2017.
As we move into 2016, I have two wishes with regards to energy. First, I hope the media gets over its fascination with the headline Oil Makes Another 10 Year Low. When it happens every third day, itʼs not news. Second, I hope investors stop trying to call a bottom on oil. I not-so-boldly predict oil will trend below $50 for a considerable time. I further anticipate significant consolidation in the sector, as do a number of investment banks beefing up staff in their Houston offices.
Finally, if you must have a position in energy, consider EOG Resources Inc. (EOG) and Concho Resources Inc. (CXO), the only two producers which have historically funded new drilling programs from cash flow on existing wells, rather than thru high cost debt.
Higher Rates Are Good. Keep Going.
The Fed has decided to begin raising rates and itʼs about time. No more artificial sweetener. No more helicopter parenting. Chairman Yellenʼs commitment to “policy normalization” ends six years of unprecedented monetary intervention and a five-fold increase in Fed assets. For anyone worried about higher rates, donʼt be. Rates are still incredibly low. The U.S. 10-year note yields just 2.2 percent currently, less than half its average of 4.9 percent since 1900. In fact, if you can afford a latte, you can afford higher rates.
Federal Reserve data indicates a median mortgage principle balance of $155,000. Assuming a 20% down payment and the current national average rate of 3.90 percent, the average monthly payment equates to $708. Even if rates rose a full one percent, the incremental cost per day would only rise $2.80, less than the $2.95 Starbucks charges for a tall latte.
Higher rates also mean companies can start pricing long-term capital projects based on more realistic assumptions. Similarly, individuals purchasing capital goods and businesses expanding operations face a new urgency to commit, since low rates wonʼt be available indefinitely. Finally, pensioners struggling to live on fixed income distributions will eventually see higher monthly payments. All of this is good. Please Dr. Yellen, more rate hikes in 2016.
My Wonky Moment: Capital Structure
Hotelier Marriott (MAR, HST) generated enormous value for investors by separating its hotel operating company from the underlying real estate holdings. Management literally split the companies in two, creating one company to manage on-going hotel operations and another to maximize use of the real estate. Investors received a tax-free spin-off of a new real estate investment trust(REIT) which avoids double taxation by passing through 90 percent of income, while still preserving exposure to a growing hospitality company.
I like deals like this and Iʼm not alone. The CEO of Hudsonʼs Bay Companies (HBC: Toronto) bought Saks Fifth Avenue and Lord & Taylor for similar reasons. Six Flags Entertainment has acknowledged the possibility of a REIT spin-off on multiple earnings calls. Sears struggles to grow its core business but offers enormous value thru real estate. True, rising rates raise borrowing costs for REITs. But given how low rates are, I am eyeing ANY company with considerable real estate holdings, from railroads to supermarkets. In 2016, I hope we see more companies convert to dual-class share structures.
Whereʼs the Beef?
I want more substance from our leading candidates in 2016. Donald, you can campaign but can you govern? Hillary, please clarify why are you more than a resume? We are thoroughly entertained by appearances on SNL but the time has come to move past entertainment and provide tangible direction for our country.
The Gallup Organization polls thousands of Americans daily on what they consider the most important issues. Currently three themes dominate and account for a collective 44 percentage points worth of concern: terrorism, jobs/economy, dissatisfaction with government. Curiously, gun control captured just 7 points, immigration 5 points and income inequality 2 points. Recall Bill Clintonʼs 1990 campaign, Itʼs the economy, stupid!
So please, no more generalized comments about building walls from one side and bridges from the other. Instead, tell me how youʼre going to make it easier for an employer to hire me, or to keep more of my hard earned money. I want specific plans which can actually get through Congress. To quote another former candidate, “Iʼm all ears.”
Use ’Em or Lose ’Em
Big box retailers changed the consumer landscape in the 90’s by offering lower prices through scale, and now Amazon has learned to squeeze even Wal-Mart by selling down to 0.7 percent profit margins. Arguably, the game has only just begun. Amazonʼs 44 million Prime subscribers equate to just 13 percent of the U.S. population, which suggests Amazon has plenty of room to grow. This is a mixed blessing.
Since consumption accounts for about two-thirds of U.S. gross domestic product, any innovation which provides lower price points generates economic growth. Thanks, Amazon. By the same token, Amazonʼs increased sales come at the expense of virtually everyone else, especially the small businesses along Main Street which simply canʼt afford to carry the inventory or compete on price.
So hereʼs my proposed compromise for 2016: If youʼre buying non-specialty items like cereal and workout socks, go to Amazon. For everything else, support your local specialty retailers. Main Street is still the tangible nerve center of America, not products Fed Exed for free and liked on Facebook.
Adam Johnson founded Insight & Action Advisors to help senior executives connect with investors and customers through video and live events. Previously, Mr. Johnson anchored several business programs at Bloomberg Television, interviewing CEOs, heads of state, Nobel laureates, asset mangers and policy experts. Mr. Johnson began his career on Wall Street, co-founding a private investment partnership and trading securities globally for ING, Furman Selz, Louis Dreyfus, Merrill Lynch. He earned his bachelors degree in economics at Princeton.