I always wonder what causes rallies like the recent Berkshire spike. Could this be a partial explanation?
From Ted Lamade, Managing Director at The Carnegie Institution for Science
Desperate for Capital and Returns
What do value investors and energy companies have in common these days? They’re unloved at best and hated at worst. As a result, their destinies might be linked. Why? They’re both desperate — energy companies for capital, value investors for returns. This desperation comes from the fact that large pools of capital have exited both en masse, in large part for justifiable reasons – namely poor performance and/or environmental reasons. Yet, the irony is that this may result in a massive opportunity for both. Why? Scarcity of capital has historically been a major catalyst for strong future returns.
The pattern goes something like this. A dearth of capital forces management teams to become more disciplined about capital allocation. As a result, they prioritize shareholder-friendly actions (dividends, buybacks, etc.) over capital expenditures. This subsequently leads to lower supply levels, a subsequent mismatch with demand, and an eventual rise in prices. When prices do rise, these businesses often become more profitable, so long as competition remains limited. We have already seen the early stages of this dynamic occurring in the energy complex, so given how badly value investors need to generate strong and differentiated returns, it wouldn’t surprise me if allocations to this sector begin to increase in a material way. As I have said before, this is looking increasingly like a Tobacco 2.0 scenario.