Note: A free 9 page report on Sequential Brands has just been issued. This ~$7 stock is from a retailer with an unique business model and at least 50% upside in 2016 as EBITDA should increase 60% this year. The report is free by clicking here. To get these weekly free reports direct to your email when they are published, please register at bretjenseninvests.com.
It has been a rocky start for investors in 2016. January opened with deep losses during the first two weeks of the year before stabilizing somewhat towards the end of the month. Still, the S&P 500's 5.1% decline in January was 10th steepest drop for the month on record. The first two weeks in February again brought heavy losses before the market seemed to find a floor for the moment and rose to end the month largely flat, at least as far as the major averages are concerned. However, sectors within the market like energy, biotech, small caps, transports and emerging markets are all in bear markets; some of them quite severe.
So what will the beginning of March bring? We are certainly off to a good start with March opening with the biggest one day gain to begin a month in some three years. However, I continue to watch these three key items that could continue to determine the direction of the market for the coming weeks and months.
High Yield Credit Markets:
One of the major headwinds to equity performance in 2016 is the deterioration in high yield credit also known as the "junk bond" market. New junk bond issuance has dried up to a trickle as total issuance is down some 70% from the same period a year ago. Most of the spike in volatility and in yields in the junk bond space has been due to the accelerating rate of defaults from small and even mid-tier energy producers who got blindsided by the severe decline of both oil and natural gas over the past year and a half.
This fear has impacted almost every segment of the market and economy that depends on this type of credit. This includes small biotech concerns that have been just hammered over the past six months as the market frets that developmental concerns will not be able to raise capital to fund trials, or will have to pay a much steeper price to access these markets. This has also impacted homebuilders than tend to carry significant debt within their business models. Many are down 30% to 40% from their highs this summer even as housing starts in 2015 had their strongest year since 2007.
Also impacted are real estate investment trusts (REITs). Many high quality names are down 30% or more from 52 week highs although they have behaved better in the past month. As I have said repeatedly in this pages recently I like the lodging part of this sector and have significant stakes in Chatham Lodging Trust (NYSE:CLDT), Diamondrock Hospitality (NYSE:DRH) and Summit Hotel Properties (NYSE:INN). All are cheap, have been oversold and all pay dividend yields between four and six percent. If the high yield market stabilizes or loosens up these names will do well and the sectors listed above would start to bounce back as well.
The price of oil is impacting the high yield credit markets as well as the overall zeitgeist of the market. Crude started to stabilize at just over $30.00 a barrel in the back half of February, which is one of the key reasons stocks rallied off deep early losses in the month. The energy market is something every investor, trader, investment bank and trading desk is watching intently right now. For most of 2016, oil and equity direction has been one and the same. That should in all likelihood should continue through March.
Key OPEC members and Russia have started to openly float the idea of production freezes, a key reason crude finally stopped its plunge after 18 months. However, given the nature and geopolitical aims of the major energy producers in these discussions; an agreement may be a ways off if one can be hammered out at all given the contentiousness of the key parties involved.
I would look for volatility coming from the oil market to continue to be factor in the market's direction in March and expect a lot of "false starts" as rumors and trial balloons from these back and forth negotiations become more common. I remain totally out of the energy sector because even at $40.00 or $50.00 a barrel crude prices, a lot of the smaller shale producers are most likely heading to major restructurings and/or bankruptcies.
The European Central Bank is meeting again on March 10th. Europe is already operating on a negative interest rate policy. However, the bank may take that policy deeper into negative rates especially after January numbers painted a picture of deflation across the continent. This will in all likelihood cause the dollar to strengthen and be a further headwind to S&P earnings growth.
The Federal Reserve also meets again in Mid-March. Everyone expects the central bank to stand pat given the anemic global economy but investors and the markets will be tuning in closely to hear comments on how the Fed sees interest rate policy going forward. Part of this outlook will be influenced by how the monthly jobs report looks this Friday. Investors want it to be strong enough to ensure the United States is not be impacted so severely by global events that it is going into a recession and weak enough that the Fed can issue "dovish" guidance when it meets in two weeks. A fine needle to thread.
Given the volatility that has been of the markets throughout 2016 so far and should remain a factor into March, I remain on a cautious stance. I continue to have a higher than normal allocation to cash within my portfolio as well as most of the rest of my holdings in lower beta large cap stocks with generous dividend yields for the time being.
Thank You & Happy Hunting
Founder, Biotech Forum
Disclosure: I am/we are long CLDT, DRH, INN.