FILL - Exxon Mobil: The Good The Bad And The Very Ugly

• Exxon Mobil's stock has nosedived 18% in just the last month.
• The drop in XOM stock is highly correlated to the 20% drop in the price of oil.
• Nonetheless, it's all about the future, not the past, when it comes to oil.
• In the following piece, I do my best to distinguish reality from repartee and come to a conclusion regarding Exxon’s future prospects.

What Happened?

Oil's price has fallen about 20% over the past month as market participants have become replete with fears of an oncoming recession.

In fact, oil fell an extraordinary 8% on Tuesday at the time of this writing.

In sympathy with oil's weakness, Exxon Mobil Corporation's ( XOM ) stock price is down approximately 20% over the past month.

At this point in time, you would be hard pressed to find anyone who has a positive outlook on oil. Just look at the last four articles on Exxon in the Seeking Alpha analysis feed! Ouch! Sell, Sell, Sell, and Hold!

Nevertheless, this is just the type of sentiment that gets my contrarian juices flowing! It the following piece I will do my best to make my contrarian case that now is exactly the time to buy, not sell, Exxon Mobil! Let's get started!

Why is the price of oil dropping?

China COVID lockdown fears

Oil's price decline is attributable to several recent developments. The spike in COVID cases and subsequent lockdowns in China have many concerned an over supply situation could be forming with China's economy being put on hold. Yet, if you dig deeper into China's lockdown program, you will see it's not as bad as it was in earlier lockdowns. I feel the China lockdown fear is a red herring at this point.

Recession fears

Fear of a recession has put pressure on oil prices. WTI crude approached $95 a barrel today falling a full 8% at the time of this writing. Since the oil sector reached a peak in early June, stocks like Exxon Mobil and Chevron ( CVX ) have fallen almost 20%. ConocoPhillips ( COP ) has plunged almost 30% since that point. The entire sector has been punished writ large.

Other issues causing oil prices to drop

Other contributing factors are the strong dollar, lack of liquidity, release of SPR stockpile, Biden's upcoming meeting with the Saudis, and oil speculator's net long positions are down 30%. In general, risk appetite in the energy sector has diminished substantially writ large. Even so, all these issues are exactly what will eventually cause oil's price to rise in the future. It's a boom-and-bust cycle. Let me explain.

Oil's Cyclical Nature

In the midst of the bust phase, excess oil supply and waning demand results in lower oil prices. What's more, with oil trading at depressed levels, under-investment occurs due to capital expenditure cuts. The oil industry is a highly capital-intense business with multi-year lag times regarding project execution. Over time lower oil prices stimulate demand while under-investment decreases supply. These dynamics form the impetus for the next boom cycle.

This is exactly what has happened over the past few years. Exxon Mobil and all the other major oil and gas companies are currently focused on returning capital to shareholders, not spinning up production. For this very reason, I expect oil's price to shoot higher regardless of a recessionary cycle ensuing. What's more, I feel the inflation fever has broken, and many may be surprised by the upcoming inflation reports coming in later this week.

Inflation fever broken?

On the macro front, future inflation outlooks have dropped to their lows for the year, a good sign that allegedly out-of-control inflation may finally be in decline. What's more, according to a recent report by JPMorgan,

"Markets now imply that headline inflation peaked in June and will soften sharply over the next year."

See below chart.

On top of this, treasury yields have pulled back to the lows they recorded in June. This is all quite uncertain, yet, for the moment, it looks as though this earnings season may not be as bad as many have predicted due to recessionary fears being overblown.

Recession fears overblown

After doing due diligence on past recessionary cycles and the respective effects on the markets in general, I surmise the potential coming recession will be a short and shallow one, even with a hard landing, for several reasons. Firstly, the average drop in the S&P 500 during the past 12 recessions since World War II was 30%. We're currently down 20% already, so about two thirds of the recession's potential downside effect on the market is already priced in by historical standards. Plus, I think some market participants are shell-shocked from past recessions causing then to overreact to current conditions, no offense. See sentiment reading below.

Extreme bearish sentiment abounds

The 52-week average of bullish respondents to the weekly American Association of Individual Investors' retail-investor survey is now below 30%.

This level of bearishness has only been seen a few times over 35 years. The Wall Street rumor mill has it that the big hedge funds are still massively short as well. I have come to see this as a contrarian indicator from my past experience. So, I employ Sir John Templeton's strategy of "Invest at the point of maximum pessimism."

Invest at the point of maximum pessimism

One of my favorite quotes from investing icon Sir John Templeton is the following:

"Invest at the point of maximum pessimism."

Templeton is known as a contrarian investor. He referred to his investment philosophy as "bargain hunting." Templeton's guiding principle was:

"Search for companies that offered low prices and an excellent long-term outlook."

I feel this statement perfectly illustrates where Exxon Mobil's stock lies right now. The reward far outweighs the risk at this time with the stock down 20% on factors that are bound to improve over time. The stock is under-owned and oversold presently.

I am cut from the same cloth as Warren Buffett

I learned this contrarian mindset from my father who was an Air Force intelligence officer for the Strategic Air Command in Omaha, Nebraska, my birthplace. He became a stock broker upon retirement. We are cut from the same cloth as Warren Buffett. I do my best to invest with the same prudence, selectivity, and midwestern values as the Oracle of Omaha himself - he lived right down the street.

A contrarian is one who attempts to profit by going against the crowd. A contrarian believes that certain crowd behavior can lead to exploitable opportunities. Pervasive cynicism about a stock can drive the price so low that it exaggerates the investment's perils and belittles its future prospects. Identifying and seizing on these opportunities is a well-known investing tactic utilized by legendary investors such as Warren Buffett, "Be greedy when others are fearful." This only works if you have courage in your convictions and plan on holding for the long run, making it a passive investment. I can with Exxon Mobil.

Bear markets throughout history

Can anyone guess how many times the market has bounced back after a steep sell off such as the one happening now? The answer is every time. Right now, bearish sentiment at record highs. This exactly the time to strike. Here is why.

Classic case of first level thinking at present

I see those selling out now as classic cases of first-level thinking. A first level thinker sells stocks as they fall and buys stocks when things are going well. The fact of the matter is in order to be truly successful; you have to do the exact opposite. Think of first-level thinking as checkers, second-level thinking as chess. Warren Buffett's quote "Be fearful when others are greedy and greedy when others are fearful" is a classic example of second level thinking.

The contrarian's code

Times of market turmoil often present the best buying opportunities for savvy investors. Contrarians find their best investment opportunities during times of market duress while others are panic selling. Nonetheless, the underlying stock needs to have a solid growth story and strong fundamentals. Here is why.

The supply/demand imbalance will worsen

Goldman Sachs energy analyst Damien Courvalin said Thursday :

"Critically low inventories in the oil market will likely send crude to $140 a barrel, despite a selloff that recently took the commodity back below $100. So, $140 is still our base case because, unlike equity, which are anticipatory assets, commodities need to solve for today's mismatched supply and demand."

Courvalin added that "robust" demand will give support to oil as well. The Goldman Sachs analyst made a comparison to the recession of 2008, saying that in the first six months of that downturn, oil prices rallied despite the contracting economy. He noted that tight supplies contributed to that response as well because inventory drawdowns continued into the recession. So, I expect Exxon Mobil to enjoy a recession proof existence for the most part. What's more, the stock has a fortress balance sheet, pays a hefty dividend, and is vastly undervalued at present.

Exxon's solid fundamentals

First of all, Exxon is basically trading for a song at the present valuation. Exxon's forward P/E of 8.67 is approximately half of the current S&P 500 forward P/E of 16. The stock is incredibly trading for a PEG ratio of 0.67, less than 1 is considered to be vastly undervalued. Finally, the Texas oil titan is a free cash flow machine, ($10 billion last quarter), which is currently trading for 14 times fee cash flow, where anything less than 15 times is considered cheap, talk about having a healthy margin of safety. Moreover, Seeking Alpha's Quant analysis rates Exxon Mobil as a Strong Buy with A scores for growth, and profitability.

Seeking Alpha Quant Rating Strong Buy

If ever there was a bargain basement buying opportunity in Exxon Mobil, this is it. Nevertheless, there are always downside risks to any thesis or investment. Please review the following.

Potential Downside Risks

It would be remiss of me not to include the positional downside risks as no investment comes without risk. Even so, the higher the risk the higher the reward. The following is a list of downside risks as I see them.

• Ukraine war ending or other supply increase scenarios.
• China's economy not coming back online;
• Fluctuations in foreign currency exchange rates, commodity prices, and interest rates;
• Inflation continuing to rise causing a recession leading to a further selloff.

The Bottom Line

Our innate instincts encourage us to depart a sinking ship. This survival tactic impacts the way we invest. The herd running for the door is what creates the opportunity to buy a fundamentally solid company like Exxon Mobil with sound prospects selling at a discount. Hopefully, you have some dry powder and a long-term time horizon and take advantage. Moreover, after years of diligent work, the company has obtained a fortress balance sheet and solid cash flow. Those are my thoughts on the matter - I look forward to reading yours.

Final Note

There's a fine art to investing during highly volatile markets such as these. It entails layering into positions over time to reduce risk. I believe the markets may have further to fall, yet attempting to perfectly time the bottom is a fool's errand. If you have an extremely low risk tolerance I suggest waiting for a well-defined trend reversal prior to starting as position. I'm in this for the long haul, so I see an opportunity at this level for like-minded investors and retirees. You can count on this stable, growing payout for years to come.

As a Veteran Winter Warrior of the US Army's 10th Mountain Division, the attributes of patience and perseverance were instilled in me, hence my investing motto "patience equals profits." Here's a picture of my unit loaded into the back of a C141 heading for home after spending a few months in the jungles of Panama in 1989, a vacation I thought would never end.

Those are my thoughts on the matter! I look forward to reading yours! The true value of my articles is provided by the prescient remarks from Seeking Alpha members in the comments section below. Do you think Exxon Mobil is a buy at current levels with earnings on the horizon? Why or why not?

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