Tuesday, August 25, 2015

Robots Panic at the Speed of Light

I was away last week, touring a potential gold project in Nevada. So, naturally, the market had to throw a hissy fit and puke up all sorts of losses. The S&P 500 dropped 5.69% last week. That’s the first 5%+ decline since September 2011.

This week started off with the Dow Jones Industrials taking a massive plunge of over 1,000 points. Then the market clawed its way back on Monday to regain nearly half of what it lost. The Dow ended down 588. Whoa! What a swing!

And now, Tuesday morning, the Dow looks poised to open up 600 points. Still, there is a real sense of panic on the Street. No one can blame investors for feeling confused. Let me show you why there is real opportunity in this market panic.

Why Is the Market Acting So Squirrely?

Earnings for S&P 500 companies are trending lower year over year. This was the initial cause for worry. Deflation led by falling commodity prices added to fears. And the general sense of dread was compounded by signs of a deeper slowdown in China.

The China government says gross domestic product grew at a 7% rate in the first half of the year. That would be the slowest growth in decades. Still, no one believes them. A Bloomberg poll of economists puts China GDP growth closer to 6.3%. Some observers say that, in reality, China’s economy may be growing as slowly as 4%.

China's manufacturing sector looks especially weak. The manufacturing sentiment index just hit its lowest level in six years. What’s more, factory orders are down and construction starts fell 16.8% over the first seven months of 2015 from a year earlier.

Why is this a huge concern? China accounts for 15% of global output. It contributes up to half of global growth. With no or much slower growth, it’s very hard to turn around those earnings I mentioned earlier.

On Monday, the Shanghai Composite tumbled by 8.5%, its biggest fall since 2007. This panicked institutions and deep-pocketed investors. And they hit the sell button.

And “button” is the operative words. A big chunk of Wall Street trading is handled by robots now. Trading algorithms are widely blamed for the “Flash Crash” that tanked stocks in May 2010. The same forces are probably in play now. Robots can panic at the speed of light. And they can change sides just as quickly, which is what we're seeing pre-market this morning.

And that’s why the Dow Jones Industrial Average dropped more than 1,000 points at the open, then spent the day zig-zagging around before closing down “only” 588 points. It’s not like the true value of the Dow 30 stocks dipped 5% at the open, then changed at the end of the day.

And that’s causing the crash you can see on the far right of this chart.


(Updated chart)

As this chart shows, the market goes through a lot of corrections. They’re scary, sure. Yet when you look at them in the rear view mirror, they are buying opportunities.

Let me make two more points …
  1. Sell-offs like the ones we saw last week and yesterday are USUALLY much closer to the bottom than the top.
  2. The really good news is some companies we’ve always wanted to buy are going to get CHEAP!

What Wall Street Forgets

So, now that we know what’s going on, let’s focus on some things that robots and the deep-pocketed white-shoe crowd might have forgotten.

China Won’t Sit on Its Hands. Today's rally is sparked by the news that China is cutting its benchmark interest rate. Why this is seen as a cure-all to China's problems I can't say. But I also think that fear over China's economy is overdone.

It's true, China’s economy is slowing down. But anyone who expects China to sit by and let its economy crash without a fight is a moron. There is probably going to be another round of stimulus spending. China has a whopping $3.7 trillion in foreign-exchange reserves to help it weather shocks. And the central bank announced it plans to flood its system with new liquidity.

And something for Americans to remember is that when the Chinese get nervous, they tend to invest their money abroad. They might even stuff some of that cash under our market “mattress.”

Market Selloffs Don’t Go on Forever. Jeff Saut, chief investment strategist at Raymond James, called the bottom on Monday. In a note on Friday, he said:
“Recall that once the markets get into one of these selling stampedes, they tend to last 17—25 sessions, with only 1—3 sessions pauses/rally attempts, before they exhaust themselves on the downside. It just seems to be the rhythm of the thing in that it seems to take that long to get everyone bearish enough to throw in the towel and capitulate. Today would be session 24. So yes, it does feel like capitulation and participants are scared.”
Saut added that after such a sell-off, it’s common for the market to finish up the next week, the next four weeks, and the next three months. He said the average return over the next 12 weeks was 5.5%.
Personally, I think the market just has to offer bargains that are good enough to interest investors. That’s when individuals, institutions and robots alike start buying again.

And indeed, we saw a lot of buying on Monday. Some big names opened way down and rallied back to close well above their lows. That can be the sign of a bottom.

You Can Be Proactive. And I don’t mean selling everything and going to cash. Instead, you should make shopping lists of stocks you want. And you can place stink bids to snatch up companies on the next panic. I’ll give you some ideas in just a bit.

Saut says odds are 50-50 that the market will go back and test support at lows it set Monday – and maybe a bit lower – before heading higher again. Or, it could take off.

Why would either of these things happen? In my view, because the underlying economy is strong. Retail sales jumped in July. Housing starts and sales are strong. Unemployment is down and hiring is up. And cheaper oil prices are putting more money in the pockets of many companies (outside of oil production) and consumers alike.

What would make it wrong is if the world – and the US – are sliding into recession. But I don’t see that.

Could The Doom-Meisters Be Right?

Dude, I have heard people declare “China is doomed” since 2005. Someday they’re gonna be right.  But are the odds any better now than, say, during the big global recession in 2008?

No. Not unless China’s leaders have lost their will to throw money at problems. Headlines like “There’s No Saving China Now” are written by and for idiots and newbs.

What About a Deeper US Pullback?

Those calling for lower stock prices here in the U.S. could be right. Bob Doll, chief investment strategist for Nuveen Asset Management, is one of the bears. He’s a smart guy. And he's waiting before putting his money to work.

"Corrections in bull markets tend to be sharp, they tend to happen quickly but they don't turn around and go back up on a V-bottom. I just want some time to pass and seek some consolidation," he told CNBC on Monday.

There’s nothing wrong with being scared. Heck, if I hadn’t seen this kind of story play out so many times, I’d probably be scared. And if you’re too scared to invest, if your fingers are burned by recent events, I understand.

But great stocks – especially stocks that pay big, fat dividends – are trading at fire-sale prices. The worst thing that’s likely to happen if you scoop them up on sale is you’ll be paid to wait. The more likely scenario is you’ll surf twin tsunamis of both distributions and price appreciation.

So let's look at one sector ...

Energy – a Volcano of Volatility

You know I’ve saying that I think oil prices will go lower for longer. I took a lot of flak for that view. But oh, I really wish I wasn’t so darned right.

In early trade Monday morning, the price of West Texas Intermediate was down about 5.7% and traded as low as $37.75 a barrel. Like stocks, crude oil recovered some losses. But it still closed below $39. Crude oil is bouncing this morning.

Prices are as volatile as nitroglycerin. No one knows for sure what will happen. But I don’t think we’ve hit bottom in oil yet. There’s too much new supply coming online from Iran, Iraq, Saudi Arabia and more. Yes, U.S. production is falling. But many U.S. refineries are set up to process foreign grades of crude. And they’ll do just that as international supply surges.

Now for the good news. You can make money even as crude oil prices drop.

Refineries are big potential winners. My Oxford Resource Explorer subscribers already own two of the best: Alon USA Partners (NYSE: ALDW) and Phillips 66 (NYSE: PSX). These and other refineries will profit as U.S. gasoline usage climbs 6.6% year over year, supporting gasoline prices, and the input cost (crude oil) falls to the floor.

And yet refineries are being sold like their storage tanks are on fire.

Heck, just look at the chart of Valero (NYSE: VLO), a refiner I always wanted to recommend but considered more richly valued than others.


(Updated chart)

You can see Valero sold off hard on Monday – then buyers came in. Maybe it’s the cooler heads who realize lower oil prices actually boost Valero’s profits. That, and the fact that its dividend yield (2.62%) was suddenly the best it had been in nearly a year.

That doesn’t mean this stock can’t get cheaper. But like I said, you get paid to wait.

We could see other winners in energy, and not just in refining.  I think companies that pay hefty dividends and can cover their distributions out of cash flow can be considered here.

If you think oil prices are near a low, you can consider buying one of the other producers as well. Thanks to the market haircut, many of them are paying dividends well in excess of their norms. And if they have the cash flow to cover it, that’s a bargain.

Some names in the big-cap producer group with hefty dividends include …

  • BP Plc (NYSE: BP) – 7.2%
  • Total SA (NYSE: TOT) – 5.8%
  • Royal Dutch Shell (NYSE: RDS-B) – 6.5%. Royal Dutch Shell has another stock and symbol, RDS-A.  The difference is tax treatment. Check with your accountant to see which is right for you.

Other potential winners include …

  • NGL Energy Partners LP (NYSE: NGL). This oil & gas refiner and marketer sports a dividend yield over 10%.
  • EnLink Midstream Partners LP (NYSE: ENLK). It connects natural gas wells to a pipeline system and markets both nat-gas and nat-gas liquids, and sports a dividend yield over 9%.
  • Targa Resources Partners LP (NYSE: NGLS) runs its own network of oil and gas pipelines. Thanks to the recent pullback, it sports a dividend yield over 11%.

Companies That Profit From Low Oil Prices

Winners from low oil prices include cruise lines, like Carnival Corporation (NYSE: CCL), which sports a 2.48% dividend yield, and Royal Carribbean Cruises (NYSE: RCL), which has a 1.4% dividend yield.

Airlines, trucking companies, chemical manufacturers, tire manufacturers – the list of winners from low oil prices is pretty long. So why are they being sold off now? Because that’s what a market panic is like.

As my old friend and super-smart trader Charlie Belida used to say, “when the paddy wagon comes along, it takes the good girls to jail along with the bad.”

Our job is to spot those “good girls.” They’re going higher in a hurry when the jail door opens.

Consider buying companies that have a track record of not only paying dividends but raising those dividends. In today’s bargain-bin market, there is plenty that is attractive.

Make Your Own Shopping List

This might be the bottom … or the sell-off might go deeper. In any case, you should make a list of great stocks you want to own at cheaper prices. You can decide for yourself where you wouldn’t mind owning great companies.

Here are seven of my “usual suspects” …

  • Netflix (Nasdaq: NFLX), recently 25% off its 52-week high.
  • Amazon (Nasdaq: AMZN), recently 19.79% off its 52-week high.
  • FireEye (Nasdaq: FEYE), recently 35% off its 52-week high.
  • United Technologies (NYSE: UTX), recently 26.4% off its 52-week high. And it has a 2.75% dividend yield.
  • Disney (NYSE: DIS), recently 21.4% off its 52-week high. A 1.4% dividend yield isn't big, but it's a nice extra.
  • Celgene (Nasdaq: CELG), recently 19% off its 52-week high.
  • Procter & Gamble (NYSE: PG), recently 24.7% off its 52-week high. And it sports a 3.69% dividend yield.

Just with those seven stocks, we’ve covered everything from entertainment to shopping to cybersecurity to biotech. There are a LOT of great stocks on sale. You’ll have to decide which ones are right for you.

If you’re smart, you’ll make a list of stocks you want, decide where you want to own them and put in “stink” bids. You never know what you might end up owning for pennies on the dollar, if the market’s panic cranks the dial all the way up to “11.”

One thing you shouldn’t do is worry too much about the market’s pullback. Longer-term, the market trend higher. Even if you’re only thinking about the medium term, you’ll probably still do well. It’s the short-term panics that get everyone confused … and offer opportunities for sharp-eyed investors.

The underlying fundamentals of the economy are strong. The long-term outlook for the market is very good indeed. And we are at a time when you can find “diamond” stocks in the market’s dust-bin.

Now is not the time to sit on your hands. Tough it out, put steel in your spine, and sharpen your pencil to whittle down your shopping list for what will probably be the best buying opportunity for at least the next five years.

All the best,
Sean

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