The S&P 500 is down roughly 5 percent over the last 3 months. There are a number of bearish signs to look out for, although there could be some opportunities in distressed debt.
Here are some notable recent key events:
- Wal-Mart is down about 10 percent on October 14. It’s extremely rare to see a mega-cap like this move by more than 4 percent in a day, much less 10. This isn’t a good sign.
- Cyclicals like Caterpillar have been announcing job cuts.
- According to the FactSet Earnings Insight as of October 9, “76 companies have issued negative EPS guidance and 32 companies have issued positive EPS guidance” for Q3. In the long run, earnings are what really drive stock market returns. Also, as of their report, “For Q3 2015, the blended earnings decline is -5.5%. If the index reports a decline in earnings for Q3, it will mark the first back-to-back quarters of earnings declines since 2009.”
I’d be positioning more defensively. I would also consider raising some cash for strategic purposes. I wouldn’t consider this the time to be bottom-fishing, but it would be good to have some dry powder for when that time comes.
What I would consider to be a potential opportunity is distressed debt in oil E&P companies. Even with the oil pullback, fracking has slowed down but not stopped. Williston, one of the boomtowns because of E&P in the Bakken formation, continues to get infrastructure developments, such as a new high voltage line for the increased electricity demand.
Some of these E&P companies probably have decent enough acreage, but they are unprofitable at ~$50 oil when they have to pay 8-10 percent coupons on junk debt. However, this isn’t to say that this acreage might not be profitable in the hands of, say, ConocoPhillips or someone else with a stronger balance sheet. I would selectively explore senior debt in 1) frackers with good acreage, and 2) bonds at deep enough discounts that potential impairments are likely already priced in. I’m paraphrasing, but a saying that I got from T. Boone Pickens’s book on why he got into private equity was that he found it easier to find oil on the floor of the New York Stock Exchange instead of drilling in Texas.
I’d be skeptical of forecasts that predict a rapid snapback to $80 or $90 prices. I did some historical examination. Between January 1986 (the furthest that I was able to retrieve data) and December 1999, WTI crude oil traded in a range of roughly $15 to $25 per barrel, clustering around the $20 mark, with the notable exception of a spike to the upper $30s during the 1991 Iraq war.
The commodity bull market in the 2000s was driven by 1) increased consumption from the rising emerging markets of China and India, and 2) not enough supply to go around. Now, Chinese growth shows signs of slowing, developed countries have become more energy efficient, and supply has risen all around. I don’t have to re-state the obvious of increased North American production, but another variable is that OPEC seems to have gone every man for himself, with countries continuing to produce at high levels. John Nash and game theory seem to be at work.
Point being: I believe a more likely scenario is a gradual rise in energy prices, and perhaps flat prices for an extended period. If China slows down, if developed markets slow down (evidenced by Wal-Mart and negative earnings guidance), and if supply stays high—none of this is bullish for energy prices.
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