Investing in Stocks: The Next Sure Thing

As a Rational Investor, I am always on the lookout for the sure thing. That is, I want to find inefficiencies in the market so great that I can exploit the correction. In that way, I can generate huge profits for my portfolio, and in my opinion, doing so with low risk. Do not misunderstand, there is risk, but I’ve found my approach to be the closest thing to a sure thing as you can find.

Let me give you an example. In 1999, value stocks were so out of style the mere mention of them resulted in cold stares reserved for those in need of a straight jacket.

At the peak of the dot com technology boom, I recognized how the market was inefficiently pricing value stocks. My response was to not buy value stocks themselves, but I bought a private company that specialized in managing money using, you guessed it, value stocks.

In 2002, the market was acting irrational once again. This time the fear was on the downside with speculators believing that the United States was heading into a Japan style deflationary period. Are you kidding? Interest rates down near zero and inflation seeds planted by the Federal Reserve made any stock buying like being a kid in the candy store. It was quite easy to go long late in that year as the market was inefficiently priced.

The Next Great Market Inefficiency

Today, in surveying the current macro landscape I wonder where I will find the next great market inefficiency. Will it be the credit space? Possibly, banks and financial companies are trading at record lows, but does that mean the market is acting inefficiently?

No, instead in this case the market is acting fairly Rationally as sub-prime derivative securities losses continue to mount. We really don’t know what shoe will drop next here. While it is tempting to dip the toes into the financial stock waters, I’ll take a pass for now.

How about homebuilding? Well, the damage has been done here and stocks are still well off their lows. That being said, shares in the space have rallied hard since bottoming. From a fundamental standpoint, shares of homebuilders trade for low multiples of book value. The problem there is can we trust book value? Will there be more asset write downs is the main question and on that front the jury is still out.

I would stay away from homebuilding in the short term.

No, what I need to find inefficiency is massive speculation. Is there a market today experiencing massive speculation?

How about oil?

Big Oil’s Time Has Come

There we go! Here we have an asset class where those on the long side, I merely chasing an investment that for the last five years or more has risen steadily. This year, we very well may be seeing a blow-off rally that could trigger a massive correction. It is simply too easy to be long oil. I get the arguments, but investors need to dig a bit deeper into the numbers. With oil it is all about… … supply and demand.

The bulls state that there is simply not enough oil to meet growing demandespecially in fast growing nations like China and India. I am skeptical of such a broad brush claim and was surprised to learn that up until recently the growth in China and India was met by increases in production from Russia.

Unfortunately, a corrupt government hell bent on exploitation for the benefit of the few has taxed oil development to the point of destroying growth in production. In the short term this has led to fear in the market that oil is indeed dwindling in supply. Frankly that is just not true. Russia alone could improve the short term situation by encouraging development in areas with proven reserves.

The other problem I have with oil is that the bulls will eventually reach the point whereby behavior will change. What happens if those speculators hit a brick wall in demand?

Boom down goes the price and hard. To me this is the most likely outcome and we are already seeing that here in the United States. In fact, the AAA forecast a 1% decline in usage over this past Memorial weekend. I can attest to this as the roads were certainly less cluttered and hotels far from full over the weekend!

Think about it for a minute. Oil is one of the most efficient markets in the world and yet current pricing is far from efficient. There is a very real relationship by supply and demand.

If price increases by 20% one can easily assume that demand has risen or supply has fallen by some usually equal amount. That is not happening in the market today. Ask yourself what has changed to cause such a spike?

Point the blame to the oil speculators. It is frankly out of control and reminiscent of the dot com boom.

What to do as an investor? I would be taking some money off the table with any oil investments here. You have had a nice run if you are long. Don’t stay at the party too long.

Richard Band, editor of Profitable Investing, agrees with me. If you do raise some cash he has some fine recommendations as to how to redeploy. At a minimum, I feel quite confident that lower oil prices is the next sure thing.

Jamie Dlugosch

Executive Editor, InvestorPlace

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