How To Handle A Correction
Stocks continue to stumble further into a “correction,” defined as a decline of more than 10%. These unnerving events occur about 20 months and take an average of 3 months to work themselves out. A “bear market” is a decline of more than 20%. There was a mild one in 2011, which recovered in 5 months and the vicious 56% trough of 2007-2009 that took four years to recover.
Like suffering from a very nasty cold, “corrections” seem endless when you are in them, yet they have always been followed by higher levels among stocks. Sometimes, a whole sector within the market takes a lasting hit, like the “dot.com” darlings in 2000-2002 or many stocks in the banking sector during the financial crisis.
Currently, the market correction seems correctly attributed to market turmoil in China combined with the uncertain effects from the continuing collapse of oil prices. This week, they dived below $30 a barrel for the first time since December 2003. Refiners and distributors are reluctantly lowering pump prices but the more immediate impact is on “upstream” exploration and production companies.
Big oil companies are deepening their cuts to staffing and investment with an estimated 250,000 jobs lost globally since the price slump. There are 38 energy companies in the S&P 500. Their income totaled $95 billion from high oil prices in 2008; this will drop to an overall loss of at least $30 billion this year.
So far this year, oil prices are down 19% and the world is awash with oil. More than 30 smaller oil companies, collectively owing more than $13 billion, have already filed for bankruptcy. Meanwhile, the reaction of most producers has been to increase production to meet their debt obligations. This is precisely what American farmers tried as the Great Depression began, forcing down crop prices until corn was a nickel a bushel, cheaper than coal, and many farmers were burning corn for heat.
Like farmers then, many oil, gas and energy services companies are heavily indebted and their attempts to avoid loan failures through stepping up production can only drive prices lower. For investors, the stability and income once provided by stocks in big energy companies have vanished. Many high-income bond funds contain vulnerable loans to energy firms and should be avoided. Over time, the big oil companies will use this period to add resources at bargain prices but their earnings and stock prices will suffer, probably for years.
Nordic American Tankers (NAT-$13) operates 26 vessels that can each take a cargo of a million barrels of oil and is doing well as diving oil prices create a strong tanker market. It just announced an increase in its quarterly dividend from $.38 to $.43, a current yield of 12%.
The finance sector had a tough year with JP Morgan Chase the only one of the six biggest banks to finish with a gain, up 5%. So far this year, they have underperformed the S&P 500, losing 10%. Profit margins have declined for several years and these big bank stocks are not attractive. Visa (V-$73), the leading provider of payment solutions to the entire sector remains a solid buy.
The market decline has taken over the financial news, yet there are a number of overlooked bright spots. The US jobs report came out stronger than expected for December 2015. So did the report for new home construction. Home prices will be pressured in energy dependent areas like North Dakota and parts of Texas but lower gas prices will aid homebuyers in most areas.
Earnings reports are starting to come in, which should bolster some stocks, particularly in the consumer sector. Corrections are a good time to develop ideas for strengthening positions, emphasizing well-financed companies with well-founded prospects for sustained growth. As the bottom develops, a useful tactic is to buy half of new positions now, using limit orders at prices well under the current market for the second half.
One candidate could be General Motors (GM-$30), a stock I have avoided for many years as generations of pompous plutocrats drove the company into bankruptcy. Its” bellwether” defective ignition switch trials begin Monday. These led to 124 deaths and to its new CEO, Mary Barra, firing 15 engineers for “misconduct and incompetence.” Sometimes, “it takes a woman.”
GM just raised its 2016 earnings guidance to $5.25-$5.75 and its dividend by 6% to $.38 a share. That’s a P/E of around 6 and a 5% yield, a better value than Ford even though GM’s projected long-term growth rate of 23% is much higher. It has a fighting chance of beating Tesla to make the first truly mass market all electric car, the 2017 Chevy Bolt EV.
Despite all the negative news, investors should remember we live in the world’s strongest economy. Looking ahead is the direction to handle a correction and, maybe, “See the world in your Chevrolet.
Tony Crowell manages stock portfolios for individuals and their trust and retirement accounts with CROWELL•ROBERTS Investment Counsel, a registered investment advisor in Laguna Beach since 1995. [email protected] 949.494.1376/800.697.2622