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Why the oil crash caught so many by surprise (but shouldn’t have)

A look at the entrenched thinking about oil prices that was so prevalent just a year ago

Why oil prices won’t be bouncing back any time soon

International Energy Agency data shows U.S. oil production has risen by 4.7 million barrels per day during the past five years, while Canada’s production is up one million bpd and Saudi Arabia has climbed by 1.7 million bpd.The surge in production comes as growth in global demand hit a five-year low in 2014, due to “a sharp slowdown in Chinese oil demand growth and steep contractions in Europe and Japan,” the IEA said in its December report.The global oil market appears heavily oversupplied during the first-half of 2015

DYI Comments:  Oil prices have taken a dive setting up an excellent opportunity to dollar cost average into your favorite oil/gas/service sector specialty fund.  Here at DYI our favorite is Vanguard's Energy Investors Fund symbol VGENX.  The fund from peak to current prices is off 27% which includes adding back in their recent long and short capital gain of $2.37 combined.

Oil prices won't stay low forever (although for speculators it may seem that way!) for the world continues to need oil based hydrocarbons especially for countries that are increasing their car and truck ownership.  The biggest of course is China and India despite this global slowdown will continue on their path to becoming 1st world countries.  Oil and gas prices are in a secular bull market this is simply a bump in the road.  An excellent time to add shares to a sector fund that is uncorrelated to the general market.

 Pills for Cognitive Dissonance in a Speculative Bubble 

John P. Hussman, Ph.D.  

For bulls, this cognitive dissonance creates the temptation to ignore the speculative risk and to dispense with valuation concerns by citing measures that have weak or zero historical relationship with actual subsequent market returns. The result is a stream of justifications for why stocks are reasonably priced and likely to advance without interruption. For bears, this cognitive dissonance creates the temptation to ignore the rising prices – to plant the valuation flag, knowing that a century of evidence on reliable valuation measures supports the strong conviction that market returns over the coming decade will be dismal (most likely negative over horizons of 8 years or less), and that the likelihood of a market loss on the order of 40%, 50% or even 60% in the next few years is quite high. 

Though I certainly believe that we’re better equipped to navigate future bubbles (and even the present one if it continues), the fact is that my defensive views have been vindicated over time, even without these adaptations – and our pre-2009 experience bears this out. 

Recall that the 2000-2002 collapse wiped out the entire total return of the S&P 500 in excess of Treasury bill returns, all the way back to May 1996. The 2007-2009 collapse wiped out the entire total return of the S&P 500 in excess of Treasury bill returns, all the way back to June 1995. 

If the S&P 500 was to experience nothing but a run-of-the-mill 34% bear market decline over the coming 3 years, it will have underperformed Treasury bills for what would at that point be an 18-year period since 1999. 

On the most reliable metrics, current valuations aren’t much different than they were then, so payback will be, well... None of that excuses the challenges we’ve had in the recent half-cycle. Again, a stronger emphasis on investor risk preferences – as inferred from market internals – should make an easier job of navigating future bubbles (or even a continuation of the present one). But don’t believe for a second that the market gains of recent years will actually be retained by investors in any event.

DYI Comments:  I've been pounding the table for some time now stating that a decline in the order of 45% to 60% is in the offering.  This is a nose bleed high market that has pushed up all asset categories with the exception of the above mentioned oil/gas/service sector and precious metal mining companies.  All others are sky high meaning 10 year estimated average annual returns going forward from here will be dismal (1% or 2%) at best and negative (-2% to -4%) at its worst.  This 10 year estimation will have a brutal bear market on its horizon.  While everyone else is losing their heads who are ignoring the fact that the S&P 500 PE10 is flying at 27 times earnings along with a minuscule dividend yield of 1.87% don't go losing yours.

DYI 

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