Over the course of the next two days, the financial news stories will be replete with opinions about whether the Federal Reserve (“Fed”) will raise rates tomorrow. Its decision will have implications for the markets – especially if it increases interest rates. What is interesting to watch is the Fed has tried to be as transparent as possible with information, yet there is more uncertainty now on whether the increase will occur tomorrow, in December or even next year. We believe it will be difficult for the Fed to raise rates next year because it is a Presidential election year. If and when and by how much it will raise interest rates is out of investors’ control. What is in investors’ control is what investments they buy and sell. Investors can make money in any investment – stocks, bonds, cars, coins and real estate to name a few. Whether you make money on the investment depends on the price you pay for it. No one knows the exact bottom price for any asset and things that are cheap can certainly become cheaper in the short-term.   That is why we believe an investment should be made with a 3-5 year time horizon.

An example of a good investment over the next 3-5 years is energy. The chart below, which was provided by BP Capital Fund Advisors, shows large capitalization energy stock prices compared to their relative price-to-book (“P/B”) ratios going back to 1928 – this is a long period of time that includes major wars, many business and interest rate cycles, and many boom/bust cycles in energy. The P/B ratio is a measurement of how much one is paying for the book value of the hard assets of a company. The P/B ratio for energy stocks since 1928 has been approximately 1.0, which means that the price of energy stocks has historically been the same as what the assets are worth. Investors who bought energy stocks in the late 70’s (P/B = 2.5x) or a few days after Iraq invaded Kuwait (P/B = 2.9x) or in 2008 when oil reached $150 a barrel (P/B = 1.7x) overpaid and saw those investments lose significant value over the next few years. Those investors that bought oil stocks in 1986 (P/B = 0.5x) did very well over the next couple years as stock prices rose during that time, bringing the P/B ratio to 1.0.

As the chart below shows, energy stocks are selling at one of the cheapest price levels based on the P/B ratio going back to 1928! There are many pros and cons in the energy sector today. As usual, the story usually lies somewhere in between. We know the price we are paying for energy companies today won’t remain this cheap forever. As John Templeton used to say – “the time to invest is when there is blood in the streets”.   That is the case with energy stocks today.

What does this mean for portfolios?

The volatility in today’s market is the direct result of recent Federal Reserve policies – starting quantitative easing (“QE”), ending QE late last year and now leaving the markets confused on the possibility of raising interest rates. The good thing about volatility is that it offers investors the opportunity to buy undervalued assets.   Energy and emerging markets are good examples of undervalued assets.   Conversely, we believe large US companies – except for energy – are overpriced. Those overweighting the former and underweighting the latter should significantly outperform the market averages over the next 3-5 years.

Sincerely,

Your THOR Team