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Weekly Wrap: Bogle Sees Low Returns; Oil Cut No Game-Changer

Jack Bogle thinks investors should temper their return expectations, and the OPEC production cut is unlikely to drive prices much higher. Plus, a look at an undervalued and underappreciated financial firm.

Mentioned:

Jeremy Glaser: Can OPEC move the needle on oil; an undervalued financial firm; and what Jack Bogle sees the market returning, this time on the Morningstar Weekly Wrap.

OPEC surprised markets by tentatively agreeing to a production cut this week, but Morningstar's energy team is skeptical that this is a game-changer for oil prices.

David Meats: OPEC members caught the market by surprise yesterday by agreeing tentatively to a production target of between 32.5 million and 33.3 million barrels per day. Although oil prices rallied on the news, our view for continued low Brent prices of $50 a barrel in 2017 remains unchanged. We see numerous risk factors that we think prevent a sustained recovery in prices until at least 2018.

First, no agreement has been formally reached with details to be agreed on at the November meeting. Even though the low end of the target range only marks a retreat to first-quarter levels, apportioning the production cuts could prove problematic given pre-existing political tensions.

Second, OPEC has a poor track record of coordinating production cuts among its members with quotas often breached or outright ignored. There are also indications that any deal might exclude Libya or Nigeria where disruptions have already reduced production and a return of volumes would offset the proposed cuts. It's also unclear how long any agreement would remain in place potentially setting the stage for resumption of growth in 2018.

The biggest risk factor, however, remains the potency of U.S. shale. We expect any OPEC production cuts and subsequent price response to be met with an acceleration of U.S. activity. The 30% increase in title rig counts since the trough in May added approximately 240,000 barrels a day of production to our 2017 forecast. Assuming an OPEC production cut occurs and oil prices rally above $50, E&Ps will likely deploy additional rigs causing higher U.S. production and potentially offsetting much of the decline in OPEC volumes. As a result, we don't see a sustained price recovery until demand exceeds the amount of supply available with Brent prices below $60 a barrel and that is not likely to occur until 2018.

Glaser: Morningstar analyst Colin Plunkett recently boosted his fair value estimate of Capital One Financial, and he sees the firm and its management team as being underappreciated by the market.

Colin Plunkett: We are raising Capital One's fair value to $97 per share from $83. Specifically, now we are projecting domestic credit card receivables growth of more than 11% this year from 7% before. But more importantly, we think this is a great opportunity to invest in one of the best management teams within financials that we can find. Frequently, the company will mention they only invest when they see windows of opportunity, and we believe this risk aversion and patience has resulted in significant increases in shareholder value over time. With shares trading in the low 70s and our fair value of $97 per share and a narrow moat rating, we believe now is a great opportunity to invest in Capital One's shares.

Glaser: Christine Benz recently sat down with Jack Bogle to get his take on the state of investing. We'll have the full interview next week on Morningstar.com., but one big takeaway was that he thinks investors need to be prepared for lower returns ahead. 

Jack Bogle: We're looking ahead to some challenges compared to what we've had in the past. Today, the dividend yield is 2%. The growth in earnings over the past 50 years has been about 6.5%. I don't think it's going to be that high. So, I use 5% for earnings growth and that gives me a 7%, roughly, a 7% investment return on stocks. The problem is in the valuations, and today the stock market is selling at about 23 times earnings, and the long-term norm is 17 times earnings. That would mean you lose 3% of that return.

Christine Benz: So down to 4%?

Bogle: Down to 4% and the bond returns, the 10-year Treasury, which is the basic benchmark, is at 1.6%. By going a little longer and a little less in governments and federal securities, U.S. government securities, you could probably get a 2.5% return without an awful lot of problems. So, you've got 4% for stocks, 2.5% for bonds, and I'll use a 50-50 portfolio, because it makes the math easier, as around 3% for a balanced portfolio.

[Our full interview with Jack Bogle will be available starting Monday]

Glaser: And if you missed it, be sure to check out our fourth-quarter financial calendar for retirees.

Jeremy Glaser does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.