The 'impossible' could now become a reality... What you need to know about 'Big Oil' dividends... The latest on our new 'distressed debt' service…
As most of you know by now, we're cautious about the market today...
Porter believes problems in the credit markets – particularly problems in high-yield (or "junk") bonds related to the oil and gas sector and emerging markets – are likely to spread... and could cause widespread declines in stocks and other assets.
This is why we've been recommending holding more cash than usual, and limiting new investments only to the best opportunities.
Of course, as we've discussed many times, there are no guarantees in the markets. No one can know with certainty where stocks or bonds are headed next. We believe risk is high, but we could be early... This long bull market could have another "inning" or two to go. As Porter explained in the October 2 Digest...
We invest with humility. We use small position sizes. We use trailing stop losses. We know our timing is unlikely to be right on the mark, so we adjust our portfolio's orientation slowly.
If we had sold everything in June 2013 and gone 100% short, we would have lost a huge amount of money. Instead, we sold some stocks and took some profits. Meanwhile, we let our favorite investments and our best recommendations continue to compound. We've cautiously added "hedges" – short-sale recommendations and pairs trades. We're still waiting for the payoff from those choices, but they haven't cost us much.
Take our example to heart. If you're nervous about stocks and bonds like we are, sell some of your investments. Sell enough so that you can sleep well at night. Sell enough so that you will have plenty of cash if a crash occurs – enough to buy good investments at great prices. But don't feel like you have to sell everything. Don't pretend that you can know exactly when a bear market will begin. Remember: Most of the time, stocks go up. That's a hard trend to fight.
But even if we're wrong – and "contagion" doesn't spread to stocks and other markets – the problems in the high-yield bond market are likely to get much worse. Too many questionable companies – especially in the oil and gas sector – have taken on far too much debt. These companies are already in distress. A huge wave of defaults is nearly guaranteed.
That's why we've been recommending readers sell any high-yield bonds they own immediately, including those in mutual and money market funds. And it's why we've been warning that it's still too early to go "bargain shopping" in oil and gas stocks.
But bondholders and energy investors aren't the only folks who could be hurt by these problems.
According to our colleague Matt Badiali, editor of the Stansberry Resource Report, dividend investors in the four "Big Oil" blue-chips – ExxonMobil, Chevron, Royal Dutch Shell, and BP – could be taking unexpected risks today, too.
In short, Matt says the "impossible" could become a reality for these companies. From the October issue of the Stansberry Resource Report...
The "impossible" in this case is the failure of one of the surest, safest income streams in the world. To many, this income stream is sacrosanct... a foundational aspect of the family holdings, like grandma's ring or the family farm.
Are the dividend payments of the world's blue-chip oil companies safe?
People all over the world are familiar with the firms we're talking about. You can hardly go anywhere without seeing the logos of major oil firms like ExxonMobil, Chevron, Royal Dutch Shell, and BP (formerly British Petroleum). Because of their dominant position in the energy food chain, these resource companies are among the most reliable in the world... known for their steady cash flows and reliable dividend payments... which are nearly as reliable as the rising sun.
This month, we're suggesting the impossible: Some of these dividends will be cut.
If you're like most folks, this may sound unbelievable. But Matt offered a compelling argument. And it all starts with two problems that will sound familiar to regular Digest readers: A foolish belief in "Peak Oil," and a flood of easy credit from the Federal Reserve. More from the issue...
If you want to know what's likely to happen with oil dividends in America, you have to understand the fantastic narrative that dominated the oil industry over the past 20 years...
It was spun around "Peak Oil"... the idea that our ability to discover and produce greater amounts of hydrocarbon-based energy had peaked, and the world would soon run out of oil.
If you bought into the Peak Oil mania, you could justify chasing oil that cost $50... $60... even $70 per barrel to acquire and produce. That's because the chart of oil prices that companies were working from was a straight line to the sky. Everyone thought oil would get more expensive.
Oil companies rely heavily on price forecasts for investment purposes. The math is simple: If the forecast shows that the price of oil will be $80 per barrel for the next few years, you don't want to find and produce oil that costs $90 per barrel... because you'll lose money. It's "uneconomic."
As Matt explained, as recently as 2013, oil companies were still using price forecast models based on the idea of oil scarcity...
For example, we can look at the U.S. Energy Information Administration's (EIA) highly influential International Energy Outlook to understand this phenomenon. In 2013, the EIA's most conservative price model projected oil prices of $75 per barrel by 2040. Its base model put the price at $163 per barrel, and its high-price model put the price at $237. By the way, all three models pegged oil prices at around $100 today. Whoops.
If you're a major oil company following one of these price models, you can spend billions of dollars developing oil assets in bizarre places. Those estimates justify taking on a five- to 10-year project with oil in the $80- or $90-per-barrel cost range.
And there were plenty of banks willing to lend oil companies the money to do it, based on those same projections. It caused billions of dollars to flow toward oil and natural gas exploration and production ("E&P") companies – all because oil prices were going to the moon.
Of course, we know now they were all wrong. New technologies combined with the flood of "easy money" unlocked huge amounts of cheap oil. Oil supplies have soared.
At the same time, demand has fallen. Developed economies like the U.S., Japan, and the European Union are using less oil than they have in years. And emerging-market demand hasn't grown fast enough to make up for it.
Naturally, falling demand and soaring supply led to a huge crash in oil prices. Now all those expensive long-term projects that made sense just a couple years ago are now uneconomic... And the massive debt loads these companies racked up are looking incredibly foolish today.
Again, if you've been with us for long, none of this should come as a surprise. But what you may not know is that even the best blue-chip oil companies accumulated a huge amount of debt. More from Matt...
From 2008 to 2014, the four most well-known publicly traded oil companies – ExxonMobil, Royal Dutch Shell, Chevron, and BP – generated average cash from operations of $35 billion per year. Based on results through the first half of this year, we show that could easily drop by one-third to $23.5 billion.
During the same period, the debt of these four companies more than doubled. It rose from $75 billion to $155 billion at the end of 2014. As of June 2015, they owed $176 billion.
We've discussed how the combination of low oil prices and huge debt loads have already pushed some low-quality producers into default... and we expect more to follow.
And while default is not a concern for blue-chips like ExxonMobil today, Matt says low oil prices are already affecting these companies...
As cash flow falls, these companies are using more of it to pay dividends:
These companies are borrowing money to maintain dividends. That's unsustainable in the long run. Growing debt is a terrible plan in the face of low oil prices.
In the October issue, Matt shared an in-depth analysis of the "dividend health" of the four blue-chip oil firms we mentioned earlier.
Out of fairness to Stansberry Resource Report subscribers, we won't share all of the details Matt discussed. But the bottom line is at least one of these company's dividends is at risk today... and if oil prices continue to fall, these companies could be in trouble.
If you have any money in these stocks today, we urge you to read the full October issue immediately. And if you aren't a Stansberry Resource Report subscriber yet, you're in luck: Matt has made it affordable for any investor to try his service. If you sign up today, you can try it for four full months absolutely risk-free for just $39. Click here for the details.
Finally, as we've explained, the news isn't all bearish...
We believe these problems in the oil and gas sector – and the high-yield bond market in general – will create huge opportunities. Porter says the next 12-36 months could be one of the three or four best opportunities in the last 50 years for people who are prepared.
These opportunities are exactly why we're preparing to relaunch our legendary distressed-debt newsletter.
New 52-week highs (as of 10/19/15): Chubb (CB) and Altria (MO).
In the mailbag, more folks respond to Porter's challenge from Friday. Weigh in on either side of the debate by dropping us a line at feedback@stansberryresearch.com.
"Dear Porter, your challenge was read, and accepted. I spent Sunday looking back at some of my worst mistakes, and realized that you were exactly right, and that I would not and could not implement your recommendation... until Thursday. Thank you for your forceful style, as that is what it took for me to focus on the wisdom of what you were saying. I'm already a TS subscriber, so I feel dumber than a newbie. Again, thanks!" – Paid-up subscriber Michael Calley
"Hi Porter, I just loved your last email and agree totally with your commentary and sentiments. In a previous business life (I'm retired now and living the disgustingly good life) I owned and wrote Australia's largest subscription newsletter for small business and I immediately identified with your writing style and frustration. I felt exactly that way too, and funnily enough, the minute I started berating my subscribers for their lack of action, the more they valued my services. It's almost masochistic.
"You used the expression – there's no such thing as teaching, there's only learning. I constantly banged on about this one – knowledge of itself has no value, it only takes on value when it is applied. When subscribers would say to me 'I know that' I would respond, 'I know you know, but I also know that you don't do what you should do.' No one ever refuted this comment.
"With respect to your commentary on investing using beta as a guide, I had one of those 'why didn't I think of this' moments. Such a simple and tremendously useful idea and I will build it into my investing model once I feel it is safe to venture into the market again. Presently, I am invested in boring 'cash' and also a number of short positions on the US and Australian markets. I really do think that Credence Clearwater Revival's 'Bad Moon rising' sets the scene for today's mood because 'I see a bad moon rising. I see trouble on the way.' Anyhow, keep sticking it to your subscribers by prodding them on the actionable steps they need to take." – Paid-up subscriber Damien Parker
"Dear Porter, thank you for a very convincing article about beta balancing portfolios. But before I get deeper into this operation I have one question. As a European I invest roughly 40% in European stocks, 30% in US stock, and the balance mostly in Asian stock. Many of my European positions are not on US stock exchanges. Is TradeStops connected to non-US exchanges. If not, I feel the result might not be entirely reliable." – Paid-up subscriber Joni Hertell
Brill comment: Richard's TradeStops software currently covers U.S., Canada, London, Australia, and Germany's stock exchanges.
Regards,
Justin Brill
Cambridge, Massachusetts
October 20, 2015
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