Is Warren Buffett Predicting a Bottom for Oil?

Warren Buffett
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So far, 2016 has been a tough ride for the markets. In just the first two weeksof trading, the Dow Jones Industrial Average has fallen 4.8%, and the S&P 500 has fallen 8%. For stocks, this has been the worst start to a year on record.

But crude oil has been hit even harder. So far this year, the price of oil has dropped by more than 20%, to less than $30 per barrel. It was the worst two-week decline since the financial crisis of 2008. And crude oil hasn’t been this cheap in 12 years. It’s looking like black mold instead of black gold.

Warren Buffett’s Berkshire Hathaway is quickly adding to its holdings of one oil company, Phillips 66. So do the Oracle of Omaha’s purchases indicate oil has reached — or is close to reaching — a bottom?

The answer: not quite.

Phillips 66, headquartered in Houston, was spun off from energy behemoth ConocoPhillips in 2012. Buffett, who already held shares of the parent company, was handed Phillips 66 stock at that time. He quickly added to his position, grabbing 27.2 million shares shortly after the spinoff. In 2014, Buffett bailed on ConocoPhillips, selling his remaining shares, along with a huge portion of Berkshire’s Exxon Mobil holdings.

PSX Chart
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Not only did Buffett stay invested in Phillips 66, but he has added to his position over time. In September he purchased more shares after revealing that Berkshire owned more than a $4.5 billion stake in the company in August.

But this week, Berkshire spent more than $450 million on the company, adding another 5.1 million shares to its portfolio, according to filings with the Securities and Exchange Commission. After seven straight days of trading, Buffett now owns 13% of outstanding Phillips 66 shares, valued at nearly $5.3 billion.

Shares of Phillips 66 surged on the news. The stock closed last week at $78.47, following a jump to $79.28 on Thursday.

This isn’t necessarily an aberration: Phillips 66 has been outperforming most other oil companies despite record lows for the price of crude. Third-quarter 2015 earnings were $1.56 million, compared with $1.01 million for the previous quarter.

That’s because, within the company’s portfolio of mid- and downstream oil and national gas operations, Phillips 66 owns 15 refineries in the U.S., U.K., Ireland, Malaysia and Germany. Together, these refineries have a net crude oil capacity of 2.2 million barrels per day. And this is key to Phillips 66’s survival despite an abysmal oil market.

Although low crude prices signal a decline for upstream producers, they actually benefit refiners. They’re able to take the cheaper crude and turn it into refined products, including gasoline. In turn, lower prices at the pump — and an improved economy — have resulted in increased demand. In addition, increasing global energy use gives an extra push.

“Cheaper feedstock costs will support refining margins,” according to BMI Research’s oil and gas analyst Peter Lee. “Regional demand for oil products at the higher end of the barrel, notably gasoline and naphtha, remains strong, providing opportunities for refiners to capitalize on higher margin products.”

So while Buffett’s purchase might indicate he believes Phillips 66 is at a low, that doesn’t necessarily mean he believes oil won’t fall any further. In fact, it could indicate the opposite.

Oil prices are not expected to recover anytime soon. In fact, analysts at Germany’s Commerzbank are forecasting the possibility of $25 per barrel. Despite this continuing downturn, follow Buffett’s lead and look for energy companies with strong refinery businesses, such as Phillips 66, to profit.

Warren Buffett is Having an Unusually Bad Year

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It hasn’t been a banner year for the Oracle of Omaha.

Warren Buffett has seen shares of his Berkshire Hathaway  (BRK.A) fall more than 11 percent this year. Even worse, Berkshire shares have underperformed the S&P 500  (.SPX) by more than 10 percent.

What makes this highly unusual is that Berkshire famously tends to underperform when the S&P skyrockets and outperform when the stocks as a whole do less well, which makes sense given Buffett’s long-term time frame. Indeed, Buffett is well known for instructing investors: “Be fearful when others are greedy and be greedy when others are fearful.”

This year, however, the S&P is slightly lower, with a 0.4 percent decline. And while there is still a month and a half left in 2015, it is notable that this would mark the first year that Berkshire A shares have underperformed in a down year for the S&P 500 since 1990. (Readers might note that this excludes 2011, when the S&P fell by less than 0.05 percent.)

The most striking year of underperformance came in 1999, when Berkshire shares fell 20 percent while the S&P 500 rose by nearly the same amount.

Berkshire stock is the victim of a rough patch for the transportation and industrial businesses Berkshire owns, as well as some unfortunate stock picks. Out of Buffett’s biggest stock holdings, IBM  (IBM) and American Express (AXP) have gotten licked this year, while Wells Fargo  (WFC) and Coca-Cola (KO) are roughly flat.

In addition, the decline in energy prices has hit Buffett hard.

“Berkshire is one of the largest operators of train portfolios, and those trains move oil and coal. As commodity prices have come down, clearly big trains have been impacted,” said Macrae Sykes, who follows the stock for Gabelli & Co.

Meanwhile, since valuations are not “depressed,” Berkshire has not been able to find particularly exciting things to do with all of the capital its businesses generate, Sykes added.

Buffett has managed to keep himself busy this year, announcing the $37.2 billion acquisition of aerospace supplier Precision Castparts  (PCP) in August. But to Sykes’ point, he told CNBC at the time that the deal was expensive by his standards, with a “very high multiple.”

Still, Buffett and his Berkshire Hathaway have generated massive outperformance over any long period of time.

Written by Alex Rosenberg of CNBC

(Source: CNBC)

Not all ETFs are Created Equal

© (Getty Images)
© (Getty Images)

When investors think about the risk in their 401(k) or other brokerage accounts, they often frame it in terms of volatility. Most often, they are concerned about sharp declines in the U.S. stock market. With memories of the 2008 market plunge fresh in people’s minds, it’s understandable that many view volatility and risk as one and the same.

But that’s not necessarily the best way to think about portfolio risk. In his most recent annual letter to Berkshire Hathaway shareholders, Warren Buffett addressed that topic, writing, “Volatility is far from synonymous with risk. Popular formulas that equate the two terms lead students, investors and CEOs astray.”

Buffett was making the point that over the past 50 years, the return of stocks far outpaced the purchasing power of the dollar, which declined over that time. The “riskier” investment in stocks is actually the way to stay ahead of inflation and maintain purchasing power. That’s a key premise behind a carefully crafted retirement investment plan.

Exchange-traded funds provide a window into an understanding of portfolio risk. Historically, ETFs tracked basic market-capitalization-weighted indexes such as the Standard & Poor’s 500 index of large U.S. stocks. On the fixed-income side, a number of ETFs track the Barclays U.S. Aggregate Bond Index (formerly the Lehman Aggregate Bond Index) of investment-grade, dollar-denominated bonds.

A broadly diversified portfolio, constructed with ETFs representing several stock and bond asset classes, has its own distinct risk-and-return profile. For example, a portfolio containing 70 percent stocks has more risk than a portfolio with 40 percent stocks. Stocks are riskier than bonds, because in a bankruptcy, debt holders are repaid before equity holders. Investors demand to be paid more for taking that risk; hence, stocks have higher returns relative to bonds.

With the information at investors’ fingertips today, it’s not particularly difficult to design a portfolio with the right asset mix to achieve an expected return over time, while dampening the volatility of stocks.

But when investors veer into more esoteric ETF products, such as those concentrated in a single sector or that use complex strategies, the risk-and-return trade-off changes.

Ron DeLegge, U.S. News blogger, founder of and host of the Index Investing Show, a weekly podcast, says the more specialized, niche ETFs should be considered as noncore parts of a portfolio.

“The core portfolio is the foundation. That’s where the bulk of the assets will be allocated,” says DeLegge, who is based in San Diego. “The core is always broadly diversified and invested across the five major asset classes: stocks, bonds, commodities, real estate and cash.”

DeLegge says in this area of the portfolio, investors should use low-cost ETFs that track broad-market indexes.

“The noncore portion of a portfolio is complementary. This is where you have things that are narrowly focused, concentrated, higher risk, maybe leveraged,” he says.

Individual stocks, he adds, are outside the core because they represent concentrated positions in one very specific asset. Likewise, sector funds, regional funds, hedge funds and actively managed funds are noncore because none track a broad asset class.

Although risk and volatility are not the same, investors are familiar with the nail-biting experience of volatility, even when their portfolio is taking a level of risk appropriate for the desired outcome. Understanding what he or she owns, and why, can help smooth an investor’s ride.

Elisabeth Kashner, a chartered financial analyst and director of ETF research at FactSet in San Francisco, says investors should be realistic in their expectations of niche or esoteric ETFs. “By and large, you’ll find that these products are not magic. Usually, if a fund has greater returns than a comparable vanilla, market-cap-weighted benchmark, it’s because it has taken on more risk to get there. If the returns are lower, it’s generally because the fund has taken less risk,” she says.

“Most of the time, the index and fund construction process has not delivered more return for less risk,” she adds. “You have to be careful. I’m not saying these products are underperforming, I’m saying they are performing in line, that their performance is driven by risk.”

Alex Bryan, an analyst with Morningstar’s manager research team in Chicago, says the category of “strategic beta” – also known as “smart beta” – has been growing rapidly. Strategic beta funds use methods like tracking indexes not constructed using traditional market-capitalization weightings. Strategic beta funds, which do have strict methodologies, differ from most active funds, which rely heavily on stock picking and generally don’t have ironclad investment rules.

Bryan says part of the growth in the category is due to fund companies marketing the products heavily. “There’s been a push on the fund company side. They can charge higher fees for creating products that look different from other people’s, whereas if you are offering vanilla, broad-based exposure, you are competing on cost,” he says.

He cautions investors to understand what they are buying if they decide to put money into an ETF that doesn’t track a broad index. “There are some where the methodology is not transparent. We at Morningstar are more skeptical if you don’t know exactly what’s going on under the hood. You want to know what are the drivers of performance,” he says.

Kashner offers similar advice for retail investors. “There are reasons to go into a complex strategy, but there are usually more compelling reasons to keep it simple,” she says. “Or, if you are going to take something simple and make it more complex, you should understand exactly why you are doing that and what you hope to get out of it. If you don’t understand that, you are probably best off keeping it simple.”

Copyright 2015 U.S. News & World Report

Written by Kate Stalter of U.S. News & World Report

(Source: U.S. News & World Report)