S&P Energy ETF vs. Apple

The Case for Investing in What you Need vs. What you Want Made Simple

Since 2020, this newsletter has used historical data to explain the case for investing in companies that make what you need while shelling overpriced companies that make what you want. KCR’s research has demonstrated that the market’s valuation structure has, and continues to, favor firms that provide popular discretionary goods and novelty technologies over companies that make essentials to human life.

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To date, the empirical evidence we relied on has proven out. Two of our mainstay themes, consumer staples, and energy, have beaten the market handily while trouncing the novelty tech stocks and overpriced consumer discretionary stocks we have panned. Many KCR readers have begun to ask if the “trade” is over.

As explained in our recent pieces on Economic Cycles and Mean Reversion, Equity Positioning & the Disposition Effect, and write-ups like Carvana’s Investor Relations and Netflix Short Interest & Regulatory Intrigue, the evidence suggests we are in the early innings of an epic rotation.

After seven consecutive years of being a top pick in our large cap ranking model and generating a 1,000% return, Apple tumbled down the ranks in January of this year. In our piece, Apple II Flashback: The Fantasy of Predicting the Future, we used simple language to explain the stock’s evolution in our rankings over the last decade.

Today we will compare Apple to the stocks in the S&P 500 Energy Index to demonstrate what we believe is an untenable disconnect between fundamentals and price. The chart below shows the total market cap of Apple and all the stocks in the S&P 500 Energy global industry classification standard (GICS code 10) since 1981.

The charts below are a simple path to seeing the more complex point we have been making around “what you need” vs. “what you want.” Driven by relentless flows into Large Cap Core Index Funds, the big have grown ever bigger. Despite the recent surge in the energy sector and a correction in Apple, the vaunted iPhone maker’s valuation dwarfs the collective market cap of energy stocks by nearly $1 trillion.

One might wonder why we are using Apple, a stock our model is merely neutral on, to make our point. KCR believes that the simple contrast between Apple and energy makes the point simple.

The navy-blue line in the chart below shows the trailing four quarters of sales of stocks in the S&P 500 energy sector ETF vs. Apple. We hope the dispersion helps open some eyes.

At a post-pandemic peak in pull-forward demand with record margins, Apple’s sales are $1 trillion lower than the entire energy sector.

The chart below simply plots the same data for profits. The crash in the GFC, the bust in US shale in 2016, and the bleeding from the Covid shutdown all stand out in energy’s profit and loss data. In contrast, Apple’s profits data is the stuff of analyst eye candy. A steady and pronounced grind higher.

Against this backdrop, none of us should be surprised that analysts have come to extrapolate Apple’s profits to grow endlessly higher and then apply liberal valuation multiples to said future profits. We should be equally unsurprised by the incredibly short shrift analysts have given to the energy complex’s newfound profits boom. After all, over the last 14 years, energy stocks have experienced significant periods of deep losses.

Yet these are behavioral errors consistent with the literature around bias and inefficient markets. KCR has been proving the folly of forecasting since our firm’s inception in 2010. More recent examples can be found in our pieces Are Cleantech Stocks a Short and Investor’s Long Term Stock Forecasts: A Perfect Path to Poverty. Those examples show how quickly these human biases can destroy investor wealth.

Our energy research has been clear. The sector has suffered from years of capital deprivation and underinvestment. The lead-in chart on our write-up Nabors Investor Relations Has a Terrific Story to Tell offers the thesis in a nutshell. This is not complicated.

Buying a new iPhone is nice. Keeping your home warm and eating food requires energy. That is non-negotiable. The world is structurally short of hydrocarbons due to the explosion of ESG investing and empirically failed government policies. The environmental crowd accidentally became “pro-famine.”

While the intentions are good, the consequences are dire. The world needs more energy. It does not need more Teslas and other environmental solutions that are rapidly failing the tests of basic physics.

KCR is a pointedly apolitical investment newsletter. We have and will continue to avoid the ever-louder ructions of our many peers who dive into the arms of various political constituencies. With that said, the recent clamor for “windfall taxes” on oil companies is rapidly becoming a non-trivial component of the long-term case for energy.

The chart below shows the cumulative taxes expensed by the constituents of the S&P’s energy sector vs. Apple. Legendary for their tax evasion skills, KCR has not heard our politicians propose a windfall profits tax on Apple.^{[i],[ii],[iii],[iv]} That our tax policies favor big tech over energy, a product the world is facing a dire shortage of, is an unfortunate testament to the times.

Egregiously misguided, these admonitions for higher taxes clash with basic economic theory and simple facts. If you want to lower the price of a good, you do not increase the cost of making it. Similarly, the concept that energy companies, stumbling out of back-to-back near-death experiences, are being villainized for earning profits and cleaning up their balance sheets is merely going to further delay the restoration of the supply side.

As we wrote in Is it Too Late to Buy Oil Stocks?, Energy investing is a capital-intensive business that requires long-term thinking. In 2016, 142 oil and gas companies went bankrupt. Another 100 followed them into insolvency in 2020. So, they’ve had a good year and a half and now we want both more production at lower costs but are going to increase their costs via punitive taxes? Stable capital structures, sound financial planning, and capital spending are critical to a healthy and continuous supply of U.S.-sourced oil and gas.

S&P500 Energy Sector ETFs vs. KCR Energy Model Portfolio

For those looking for an alternative to invest in Energy, please see the fundamental comparison below of KCR’s Energy model portfolio and the XLE Energy Select ETF, the XOP Oil and Gas Exploration & Production ETF, and the XES Oil and Gas Equipment & Services ETF.

While others continue to trade speculative stocks based on the potential for a Fed pivot, our work has and continues to make the case for GARP investing, safe dividend stocks, and other investments that offer a margin of safety over more speculative valued companies.

KCR has no idea what the Fed will do next. What we do know is that the gag-reflex trading around the potential for cuts strikes us as an exercise in foolishness for many “long-duration” stocks. We ask those obsessed with Fed forecasting the following:

• How have you done so far, and what is your edge going forward?
• If the Fed cuts rates, will it actually make the market’s most expensive stocks good investments?
• If your answer to the above is “yes” – why will it be different than post the dot.com boom and the 2007 debt-induced boom? In both those periods the Fed slashed rates, and it did nothing to stave off disaster for speculators

For those still chasing the ARK complex, we encourage you to listen in to George Noble’s terrific Twitter spaces where he brings some of the industry’s most experienced investors’ views to much-needed light. KCR would also highlight our recent piece Macro Research: Will Math Ever Matter in the U.S. As we explain, the Fed’s position is not one we would wish on our worst enemy. The U.S. cannot afford to raise rates, hold rates here, or cut rates.

In our upcoming piece we will blaze through 100 years of financial history to explain the growing risks to Fed traders and bondholders alike. The past offers a view into the future, and the lessons we learned about the playbook the Fed is using and nobody is talking about offer a dismal future for those looking to hide in cash.