This article concludes a topic I have been discussing all week: the value of understanding your circle of competence, that is, knowing what you know and knowing what you don't know. And one of the things I think most will agree with is that the market, from time to time, will over react as it did during the Internet bubble and the recession of 2008. Over time, markets tend to revert back to the mean from those extremes. Investors who are patient can benefit from that.
I see two such extremities in the market today that provide very fertile long-term opportunities.
The first is the price of oil. To be sure, the decline from $100 to $50 a barrel is not that extreme in the context of mean reversion. Oil at $20 a barrel, on the other hand, would be. However, what the decline in oil has done is create some extremities with respect to oil related businesses. For instance, Canadian oil company Bellatrix Exploration (BXE) currently trades for $3 against book value of over $5 a share. In 2014, average daily production nearly doubled to 39,000 barrels of oil equivalent per day compared with 21,000 in 2013. Proved and probable reserves have more than quintupled since 2010. Operating costs are one of the lowest in the industry. In other words, Bellatrix is doing fine today. If oil settles around $60 to $70 a barrel, shareholders will be happy.
Chesapeake Energy (CHK) is another spring waiting to coil. Natural gas prices below $3 per TCF is not going to be a permanent condition, despite all the successful fracking going on in the U.S. And natural gas does not need to even come close to the $12 to $13 prices we saw pre-financial crisis for Chesapeake to reward shareholders at current prices.
The other extremity which is even more pronounced is interest rates. Zero percent rates are not going to be here forever. They will climb higher as economic forces dictate, despite the fact that the Federal Reserve can control the lever. Financial institutions, many which have become very efficient in a zero percent world, will find profits climbing when rates go up, as lending rates tend to climb faster than deposit rates. Bank of America (BAC) and even smaller regional banks like TowneBank (TOWN) will go from having headwinds to having tailwinds.
Five years ago, no one could imagine that stocks would be booming and earnings would be climbing. Years from now, when rates are higher and oil prices climb, those who cast their bets today will be in the driver's seat.