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 Q1 Publishing's Founder and Chief Investment Strategist Andrew Mickey expects to see the U.S. stock market slip as much as 25% over the next 6 to 12 months, he tells Energy Report readers. In this exclusive interview, Andrew discusses lithium, LNG, manganese and one of the only ways regular investors get into the fastest growing venture capital sector.
The Energy Report: In one of your recent articles, you suggest that even if good economic news continues coming out next year, the market is likely to drop 20% to 25%. Would you go through the logic that leads you to that conclusion?
Andrew Mickey: If we look back to the way the stock market has moved over the past 20 to 30 years, it has always been valued relative to earnings. The most common valuation for the market has 15 to 20 times the 10-year average annual earnings. That smooths out the up-and-down years and brings you to a fair valuation—with the S&P 500 between 800 and 1000. Granted the stock market goes much higher and much lower than that—and can stay at an extreme for longer than most investors expect—but it always returns to its fair value.
Now that so many stocks have had a great run, the S&P is up to around 1100 and it's overvalued. The market basically has a lot of positive expectations built in. Earnings estimates are starting to rise, though all CEOs are still trying to keep expectations low. Economic expectations are rising. Expectations for everything are rising and we've learned consistently throughout the years—great expectations usually lead to great disappointments.
So as long as GDP growth is low, the market will fall right back to fair value. That's why, even with the big picture news getting better, the very real risk is that it's still insufficient to hold the S&P up at 1050, 1100, or wherever it does eventually top out at.
We may not have an outright crash because everyone is still on watch, but probably a slow, steady fall over maybe six months to a year.
TER: Are all sectors currently overpriced, or will some continue to appreciate?
AM: There will be some that will appreciate. But it won't be a case of great or greater returns like we've had. There is some great historical research done on the way stocks move. One important factor is the factors of market, sector and stock. If you break it down, basically 50% of a stock's movement is usually tied the overall market.
There's nothing you can do about the overall market, but there still is opportunity in that another 30% of that stock's move depends on the sector. And the remaining 20% can be attributed to the individual company. In other words, you can expect the initial impact across all sectors. There will, however, be the divergence between the quality and value and all the garbage that's done so well recently.
TER: How much focus should individual investors put on international investments versus North American-based investments in this environment?
AM: A lot of it depends on your time horizon. If you have five years or more, you can build a reasonable case for focusing 30% to 50% of your money in international stocks.
That's a very high concentration for any portfolio in any particular sector. If you're looking out that far, you definitely want to be in the emerging markets. In the short term, the falling dollar has been very helpful to some of the really large, high-quality U.S. companies.
TER: Another of your recent articles suggests you're pretty bullish on lithium due to the growing demand for lithium ion batteries. But why lithium rather than the battery market in general?
AM: Hybrid electric vehicles (HEVs) and electric vehicles (EVs) are going to be a big opportunity. And history provides a good precedent for how to invest in them successfully. For instance, let's compare it to the growth of computers. Everyone was getting them in the '80s and now they've become standard parts of most folks' lives. By the mid '80s, about a decade into the growth of computers, everyone knew that it was inevitable that everyone would have one in their homes and in every office around the world. But if you tried to pick a computer maker, you'd have to be right about which company to invest in and at which time. You'd have to buy Apple early, then Gateway and Dell, then Apple again. That's a lot, probably too much, to get right.
That's kind of what we're seeing with the HEVs and EVs. The producers battle it out for market share. Toyota and Honda have led the way, but there are a lot of companies catching up to them. It's anybody's guess who the winner will be. But there is one thing we do know; the market will be very competitive. And in a competitive market, maintaining market share kills profit margins and you'll see stock valuations usually follow the profit margins up or down.
Right now dozens of companies are trying to produce HEVs, EVs and the batteries to go along with them. They all have their own specific deals, so at this stage, I am not going to even try to pick the winner. The odds are so stacked against you.
But the bottom line is this growing industry will demand lithium. We know that. So we might as well just go there. It makes it all easier and cuts down the risk of trying to figure out the right company at the right time.
TER: So it doesn't really matter who wins the battery race. You just know they're going to have to use lithium.
AM: Exactly. But I know there are even competing technologies with lithium ion batteries too, such as super capacitors. They may even be better, safer and more efficient. But lithium will be the winner because the U.S. specifically is going to invest $27 billion of government money into batteries and alternative fuel for vehicles over the next few years. Maybe $10 billion or $15 billion has already been doled out. If you look where that actually goes, more than 90% of it is going to lithium ion battery research, building lithium battery factories and outright buying the batteries for the U.S. automakers.
So another technology may be better, but it has to compete against a reasonably good one that has been heavily subsidized.
Another positive for lithium is the lithium production industry is dominated by a small group of companies. It reminds me of a similar opportunity we jumped on back in 2006 when I first started researching potash. The potash is dominated by two global oligopolies. They semi-openly work together to fix prices at the highest possible level. It's kind of an obscure industry, so they get away with it. You aren't going see Congress calling "Big Potash" to testify the way oil executives are called when oil prices are up.
That's why the lithium industry can be dominated by a few large companies and continue to be for years. No one is likely to stop them.
That's basically what the lithium makers do, too. In an unofficial way they're an oligopoly. They fairly easily expand or cut capacity to match market demands. And their costs are all similar. So they don't go out battling it out for market share. They know they can all make some money as long as no one gets too aggressive.
It's not illegal or anything like that. Just look at how often the cell phone companies and rail liens lose money. They don't because they all get along. It's just how it is. The way I see it is they've been working together for maybe 20 or 30 years, this is the golden era they've all been waiting for, and the odds of one breaking from the group are very low.
TER: So where are the investment opportunities under those circumstances and with the market so tightly controlled by the leaders?
AM: There is room for small juniors as long as they can compete on price.
TER: With record production of liquefied natural gas (LNG), record levels of storage and the world dumping LNG on the U.S.; where is the opportunity?
AM: Well, that's why I'm staying away from the natural gas producers in the U.S. Most of them have returned back to the same levels they were at in 2005, which was when the natural gas market was tight and getting tighter.
It's not 2005 in the natural gas market and there's just not going to be a huge rebound in natural gas demand. Still though, waves of LNG tankers are coming toward the U.S. as we speak. So I don't necessarily like the U.S. producers because they were paying them a $1 per Mcf just to buy reserves and then production costs on top of that. Frankly, a lot has to come together economically for natural gas demand to roar back. It's possible, but investing is about odds, and odds are against it.
TER: And it's a different story overseas.
AM: Absolutely. In Asia, companies are buying natural gas for less than 10 cents per Mcf—even cheaper in some cases. So you can buy the same amount of natural gas in Asia for 90% less than you can in the U.S.
There are more risks, but you're getting a huge head start. That puts them way ahead of the U.S. companies. Even after the costs to ship an Mcf of LNG, they're still well ahead of U.S. producers expanding into unconventional reserves when it comes to costs.
TER: What other trends are you're following in the energy sector?
AM: Companies going green. It's not necessarily environmental consciousness or because they buy into the global warming nonsense. The simple reason is you can charge customers more in the green space. A recent survey found that customers are willing to pay as much as 5% to 10% more for a product, just because it's green. That creates a situation where if you can green your products for an additional 2% cost, you can increase your margins, as well as use green to take market share. So, there's a huge opportunity there in green marketing.
TER: Thanks so much for your time today, Andrew.
Andrew Mickey is Q1 Publishing's Chief Investment Strategist. Q1 Publishing provides investors with "well-researched, level-headed, no-nonsense" business analysis and advice that claims to filter out 99.9% of the noise in the financial world to help investors "secure enduring wealth and independence in today's turbulent financial markets." Its products include subscription-only communications such as Andrew Mickey's Prudent Investing and the President's List as well as a free eletter called Prosperity Dispatch.
Andrew's investment philosophy is based on being prudent (limiting risk without surrendering upside potential), paying close attention to risk-reward relationships and evaluating a variety of asset classes. He searches relentlessly for explosive assets and businesses off the beaten track, traveling often to unearth hidden gems. Over the past few years he has visited Indonesia, the Ukraine, Papua New Guinea, Russia, Mexico, Australia, China, Thailand, Albania, Croatia, Norway and many other places. His research has been featured on CNBC, BNN, BusinessWeek and other media outlets.
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