The oil business, and why industry sector bets are a terrible idea

The first half of the year is over. To say that international markets ran away with it would be an understatement: emerging markets, with dividends, are up 20% in 6 months, and other international markets are up over 15%. There are a few things we like at One Day In July. The month of July itself, for starters. But when indexes start to diverge from each other, it plays to the strength of our model and we have ourselves a bit of a chuckle.

I only like this type of performance for clients who are in or very near retirement, or are in a place where they need to sell their capital assets. For everyone else, I don't chuckle for long with markets rising. Generally we are buying assets for people at One Day In July, aiming to build up their own small business for them, and I don't want to pay more for the same share of ownership and future dividends. With that in mind, U.S. real estate has me a little interested. After dividends, it's gone nowhere for six months. Six months is too short a time period to mean much, hence the "little."

We talk a lot about index funds. This month let's explore an industry, energy, that makes up part of these funds, and discuss why betting on a single industry is not a good idea. It's relevant because more and more so-called "index" funds track specific industries (at higher fees to the investor, or course.)

My seven year old son recently wanted me to take a photo of him pumping gas into the car. I asked why and he said "So my kids can see how silly it was that we once went to gas stations. They won't believe me."

The oil industry, medium to long term, is in deep trouble. Why? It is a capital intensive industry, when demand for its products drops a little price collapses, and the industry is now realizing it's competing with the powerful force of Silicon Valley. It has high externalities environmentally, in human life (particularly in Africa), and in geopolitical unrest. To mitigate these externalities, the U.S. government spends much effort protecting its supply lines and shipping lanes.

If that weren't bad enough, its product, just on a standalone basis, is not attractive. Think about gasoline, the primary product of the industry. It has one redeeming quality: due to its chemical composition, it stores a lot of energy (originally from the sun), with a good output to weight ratio. Beyond that one sparkle of light: it's flammable and burns up thousands of motorists a year, it smells bad, it's inconvenient because you have to stop at gas stations to get it, it's expensive, and it pollutes the air you breathe.

Not to pile on here, but the third huge problem area is potentially the worst. For at least forty years a large percentage of America, perhaps a majority, has pined *not* to buy the industry's products, but did not have a viable option (cable TV industry, take note). This is a huge liability that appears nowhere in the GAAP accounting statements, but is very real. The moment this customer group gets an opportunity to leave, they do, and it often becomes a stampede (Opec this morning quintupled its electric vehicle forecast). One week ago today, Elon Musk at Tesla, abusing only a small percentage of his employees, hit his targets and delivered the first mass-production electric vehicle off the production line.

This is demand evaporation, and it is brutal as a business manager. Customers simply don't want your product anymore (take an electric car for a test drive - you'll never want a gas engine again). Managers for years scurry around rearranging the chairs on the deck of the Titanic trying to create demand, but in the end the ship still goes down.

Anyone who was involved in the tech business in the 1980's through today knows how fast demand can shift. Charts and forecasts like these may turn out too favorable to the existing industry. American and global entrepreneurs look for big problem lists like this. It spells opportunity in two huge businesses: energy and transportation. And it has the characteristics of silicon, in that new solutions get exponentially better. Exponentials creep up on old industries quickly.

Despite the large decline in oil-based index fund industry trackers over the past few years, I wouldn't expect a rebound. The history of capitalism shows industries rarely adapt to a new, dominant technological force. Demand continues its inexorable shift and the old players, even entire industries, get swept away, often ending up in bankruptcy, or cut apart for assets. Think about Kodak and photography, Digital Equipment and minicomputers, Sears in retailing, or your local newspaper. Coming generations probably won't even know what Exxon was, except maybe a weird word that had two "xx's" in a row.

The lesson? Even if an industry sector seems cheap, and is represented by an "index" fund, it may behave similar to a stock, where it continues to decline, it just flatlines as a "living dead" industry for decades, or it goes to zero. It's a bad idea to make these specific bets.

Remember, the stone age didn't end for lack of stone. It ended for lack of demand.

Return to Articles
How Are We Different
Understanding Your Financial Statement
Articles on Investing
Investing with Low Cost Index Funds
Pay Yourself First
Why Use a Fiduciary Financial Advisor?
Financial Planning
Quarterly Booklets
Simple, Low Investment Fees
Investor Resources
Investment Tools
Financial Firm Comparison
The Investment Process
One Day In July in the Media
Local Financial Advisor
How to Switch Financial Advisors
Frequently Asked Questions
Book Recommendations
Types of Investors
One Day In July Careers
Prospect Booklet
Square Mailers
Fee Calculator
Types of Accounts We Manage
Options for Self-Employed Retirement Plans
Saving Strategies
What to do When Receiving a Pension
Investment Tax Strategy: Tax Loss Harvesting
Vermont Investment Management
How to Invest an Inheritance
Investment Tax Strategy: Tax Lot Optimization
Vermont Retirement Planning
How to Make the Best 401k Selections
Investing for Retirement: 401k and More
Vermont Wealth Management
How to Rollover a 401k to an IRA
Environmental Investing: How it Differs from ESG
Vermont Financial Advisors
How to Invest for College Savings
Should I Try to Time the Stock Market?
Mutual Funds vs. ETFs
The Cycle of Investor Emotion
Countering Arguments Against Index Funds
Annuities - Why We Don't Sell Them
Aim for Average
How Finacial Firms Bill
Low Investment Fees
Understanding Fixed Income: Interest Rate Risk
Investing in a Bear Market
Investing in Gold
Is Your Investment Advisor Worth One Percent?
Active vs. Passive Investment Management
Investment Risk vs. Investment Return
Who Supports Index Funds?
Articles by Dan Cunningham
Does Stock Picking Work?
The Growth and Importance of Female Investors
Behavioral Economics
The Forward P/E Ratio

Saratoga Springs, NY Financial Advisor

73 Henry Street

Saratoga Springs, NY 12866

(802) 735-8772

Shelburne, VT Financial Advisor

145 Pine Haven Shores Road, Suite 2212

Shelburne, VT 05482

(802) 777-9768

Wayne, PA Financial Advisor

851 Duportail Rd 2nd Floor

Chesterbrook, PA 19087

(610) 673-0074

Burlington, VT Financial Advisor

77 College Street #3A

Burlington, VT 05401

(802) 503-8280

Rochester, VT Financial Advisor

Available for meetings in Rochester, VT and surrounding areas.

(802) 829-6954

Bennington, VT Financial Advisor

Available for meetings in Bennington, VT and surrounding areas.

(802) 735-8772

Hanover, NH Financial Advisor

26 South Main Street #4

Hanover, NH 03755

(802) 341-0188

v 2.4.7 | © One Day In July LLC. All Rights Reserved.