This is confusing but also not.
In a note to clients on Monday, Morgan Stanley’s Adam Parker admitted he was wrong to be bullish on oil-related stocks and now wants to be less bullish. But Parker is also worried that this flip-flop will make him wrong again.
“Firstly, we are downgrading energy from overweight to market-weight,” Parker writes. “
We made a really bad call by going overweight energy at the beginning of this year… We are clearly burned by our wrong overweight, and worry that this downgrade could be the beginning of an energy rally
And while oil prices crashed about 50% late last year and Parker wanted to buy the dip, prices kept falling and have stayed low while oil stocks have taken a beating.
But beyond the actual call, it’s also worth thinking about this rationale as the latest example of why we are all behavioural economists now.
By getting his call to buy energy stocks wrong, admitting this, and then recommending investors go the other way, Parker worries he may simply be giving in to his own human bias towards making irrational decisions and thereby enabling the contrarians to take advantage of his call.
Over the last 20 or so years, the ideas of “behavioural economics” and “neurofinance,” among other related areas, have become the driving force in market thinking.
The core idea here is that since market participants are humans, it’s worth thinking about the irrational and contradictory ways humans act and then using this information when thinking about potential market outcomes.
This thinking has led to an emphasis on passive indexing — or putting money in something like an exchange-traded fund and leaving it there for a long time — to cut down on mistakes we make by acting emotionally as investors.
And something like a behavioural bias has also upended the dominant idea held for many decades that markets are efficient and reflect, or will in due course, all known information about a stock and value it accordingly. Under this belief, you want to back up the truck to buy a stock that looks undervalued because the market will inevitably prove you’re right.
Now, it seems that conventional wisdom is dominated by something approximating the exact opposite idea. In short, believing in the market is almost like asking to be proven wrong despite best laid plans.
As for the actual energy sector downgrade on Monday, Parker still thinks there are sound reasons for this, writing:
It always stings to get it wrong in both directions. Nonetheless, we have new information since the original upgrade and our judgment is, why hold a losing bet when we have new information? Non-US supply is higher, in both Saudi Arabia and potentially more than anticipated in Iran in 2016. US supply is far greater.
Moreover, it is clearer now than ever that technology has massively altered the energy landscape… Our original thesis when we went overweight the energy sector at the beginning of the year was that they were cyclical stocks that were down a lot, you had to be anticipatory and the valuation was compelling. We thought the falling rig count would be a catalyst to spark a dream of higher oil. Well, we now think rig counts aren’t the way to think about it. It is production, and production isn’t down really at all in the US… The valuation argument only works with a dream of a much higher oil price in the future, and that dream has been a bit of a nightmare.
All in, it’s been a reflective Monday for Parker, who also isn’t sure what to think about how to value stocks anymore.
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