We’ve been getting this question a lot lately, fueled (no pun intended) by a common media narrative about how the decline in oil prices is going to ruin the economy and Canadian dollar, with no hope of ever recovering.
Economics 101: There is a bottom, even if it’s not yet in sight
First, let’s talk about the economic impact of falling oil prices. In a recent Pension & Investments column, we spotted this quote from a U.K. stock portfolio manager: “Everybody is worried that the price (of oil) doesn’t seem to have a floor at the moment.”
Well, of course it has a floor. There are any number of propositions ranging from reasonable to raving on why oil prices have been dropping, such as these “Six conspiracy theories behind plunging oil prices,” shared by a Globe and Mail columnist. But common sense as well as Economics 101 informs us that, regardless of the myriad of reasons behind the current pricing, supply and demand must eventually shift, preventing prices from plummeting to the point where gas stations are paying you for the privilege of filling your tank.
To quote the late Andy Rooney, one of America’s most curmudgeonly news commentators, “It’s just amazing how long this country has been going to hell without ever having got there.” Rooney was referring to the U.S., but the sentiment applies equally well here.
Economics and Investments: Related, but distant cousins
Now, to investing. Even as we may appreciate the low, low prices at the gas station, we fret that any major economic influence that is changing this much, this fast, must somehow lead to a market downside and must call for swift avoidance tactics.
Not so fast. The relationships between economics and market prices aren’t as directly cause-and-effect as most investors are led to believe. In reality, there’s not much you can do after economic news is released, because of the way the markets adjust their pricing in response. It’s not the news itself; it’s unexpected news that alters future pricing. So although oil prices are low, future stock prices will rise or fall depending on whatever unexpected events happen next, which by definition, are impossible to predict.
Advisable investor response to oil pricing news
If you have an overly concentrated portfolio of energy stocks, then, yes, you should be worrying. Unfortunately, the damage to your concentrated portfolio has already been done, with no way to know what the future holds for your current holdings. The best you can do now is to heed the lesson learned about having placed too many of your investment eggs in too few baskets, and take appropriate steps to avoid getting burned next time.
This does not mean it’s time to shift to a different concentration by chasing recent outperformers such as REITs, non-resource based Canadian stocks or very large US Stocks! Any overly concentrated portfolio runs the risks of giving you déjà vu all over again when its turn for a downturn occurs. Instead, we recommend working with a professional financial advisor to help you shift toward a more globally diversified portfolio that reflects your personal financial goals and circumstances.
If you already have a globally diversified portfolio with exposures to stocks that are impacted by lowered oil prices in diverse ways, you’ve already prepared for riding out the current risks and capturing current rewards as best as you can in our uncertain world. As financial author Larry Swedroe explains, “Diversification is like insurance. It’s insurance against having all your eggs in the wrong basket. And a strategy that involves buying insurance is working whether or not you collect on the policy.”
So, as a globally diversified investor, give yourself a pat on the back and get on with the rest of your life. Maybe go enjoy a road trip, compliments of that inexpensive gas.
PS: Are you unsure whether or not your portfolio is properly diversified? Don’t worry, that’s a common uncertainty. Give us a call, and we’ll be happy to run an objective, complimentary analysis to find out.