Since July 2015, we have repeatedly gone on record voicing concerns over the equity markets and continue to believe that we are at the beginning stages of a U.S. recession.
The most recent casualties of the market selloff are the most-loved glamour stocks (including FANG), which had appeared to be unaffected by the problems of energy companies, commodity producers, banks, retailers, etc.
This bifurcation of market values represented an early warning sign in our view. We believe that a major area of the market such as energy cannot be teetering on collapse without pulling down the entire market. We saw this with financials in 2008 and technology in 1999.
Another troubling statistic was put forth in a recent Bloomberg article showing 394 dividend cuts in 2015 versus 295 in 2008.
In 2007, the industries that were overvalued included financial, luxury retail and homebuilders, with much of the bubble being brought about by no-look mortgages, and a seemingly insatiable appetite by global investors to invest in these packaged, derivative instruments.
When investors realized that many people could not afford their no-look mortgages, the bubble broke and the gravitational pull brought down the entire market. This put the market into a death spiral as leveraged investors needed to sell anything that had a counter party to meet margin calls.
At the depth of the market selloff in 2009, certain companies could be bought for the value of the cash they held on their balance sheets, with no assigned value to their operating businesses.
While the bubble stocks have stayed down and may never come back to 2007 values, the non-bubble constituents caught in the delivering backwash did come back. The wait, however, was painful for investors.
While we see some similarities with the current market selloff, we see major differences:
First: The decline of energy producers was not brought about by the bursting of a bubble. Their decline is a product of new technology unlocking reserves in the United States and bringing an abundance of what was once thought to be a scarce and diminishing commodity.
Additionally, Russia, Venezuela, Iran and Nigeria, need to sell oil at virtually any price to avoid depression.
Second: The collapse of Bear Stearns and Lehman Brothers, the shotgun wedding of Merrill Lynch and BOA, and the would-be collapse of many other financial institutions, such as AIG (NYSE:AIG), were able to be fixed or delayed with an injection of cheap cash from the Fed.
The Fed won't pump cash into Chesapeake Energy (NYSE:CHK), ConocoPhillips (NYSE:COP), or any other energy companies as they teeter. The energy complex will experience a period of recapitalization with bankruptcies, loan write-downs, suspended dividends, bond holder defaults, recapitalizations, etc. This distress will ultimately affect consumer behavior and the broader U.S. economy.
Oilfield, construction and other industrial jobs have been important catalysts for the job market, employment and wage gains in recent years. These jobs will be soon lost, causing a spillover effect to other consumer dependent industries.
While investors come to grips with the market volatility and the extent of the economic malaise, we are beginning to prepare for the next phase, which is taking advantage of the significant opportunities that we believe will be forthcoming over the next 12-24 months.
We are of the view that Emerging Market economies with large populations (China, India, Indonesia) and exploding middle classes will offer investors the best opportunities over the next investment cycle, although EMs reliant on energy and commodity production will lag.
Some specific names that we currently like in consumer based EMs include:
- Hindustan Media Ventures - India; Publishes a Hindi newspaper in India.
- Turk Tuborg Bira - Turkey; Produces, exports beer and malt. Owns license from Carlsberg.
- Human Soft - Kuwait; Education services company that offers higher education and training services.
- Shandong Luoxin Pharmaceuticals - China; Research, development and sale of pharmaceutical products, including antibodies, anti-viral medications and system specific medicines. The company has over 250 products approved in the People's Republic of China.
Disclosure: I am/we are long HINDUSTAN MEDIA; TURK TUBORG BIRA; SHANDONG LUOXIN PHARMA; HUMAN SOFT.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: The Stanley-Laman Group, Ltd. owns shares in the companies mentioned in the article; Hindustan Media; Turk Tuborg Bira; Human Soft and Shandog Louxin Pharmaceutical through its management of the SLG International Opportunities Portfolio, (IOP) a Private Offering that specializes in acquiring stocks of high growth companies listed on foreign exchanges and traded in local currency. The Fund available to Qualified Investors by Private Offering Memorandum Only.