Recession Drumbeats from the Jungle - Crouch Connection, February 2016
Recession Drumbeats from the Jungle
Unfortunately, not much has changed since our last epistle about the world of finance. Volatility and uncertainty have been the norm, and positive news has been scarce.
Oil prices have rebounded somewhat from the drop below $30, but almost all analysts seem now to agree that $20 is almost a certainty ... now that is a problem, because I begin to get nervous when everyone starts agreeing with me! This time I believe they have finally read their Econ 101 textbook. The International Energy Agency stated in a report released January 21:
"We conclude that the oil market faces the prospect of a third successive year when supply will exceed demand by 1 million barrels per day and there will be enormous strain on the ability of the oil system to absorb it efficiently."
So think about it ... as long as production is going up, what are prices going to do? The laws of supply and demand say prices will continue to fall ... good for us when we refill our gas tanks but, as we have found, very challenging to economies around the world, including our own.
Lower oil prices are putting pressure on companies and countries around the world that have enjoyed the benefits of high oil prices for several years. Now companies continue to emerge blaming the oil prices for weakness in their business. Last week, even the Boot Barn blamed oil prices for the slow sales in markets that are dependent on the energy industry. Nigeria recently asked for financial assistance from the International Monetary Fund, and Brazil is teetering on the edge of default.
We are now seeing warnings that bankruptcies in the U.S. oil industry could cause severe stress in the financial system. Signs of stress in the bond markets have recently reached levels that cause market-watchers concern as Moody's Liquidity Stress Index jumped to 7.9% in January from 6.8% previously -- the largest one-month move since March 2009. Credit default swaps, essentially insurance policies against bankruptcy of global banks, have also risen sharply over the past month.
(Now this is where it gets really difficult to write a newsletter ... the Super Bowl just started!)
Recessions and Cyclical Stocks As I have explained to many of our clients at our annual meetings, cyclical stocks can be the investor's best friend or their worst enemy, depending on when you decide to buy or sell them. So the next question naturally is, what is a "cyclical" stock?
If you think about it, when the economy begins to slow and the media begin to speculate whether we are headed for another recession, most folks begin to slow their spending. But they don't hold back on all of their spending. Normally we continue our spending for groceries and detergent, but when it comes to the bigger ticket items ... think cars, homes, furniture and appliances, tires ... most of us tend to put those purchases on hold. Those are the companies we call "cyclical," and their stocks begin to fall well before we see a slowdown in earnings. Historically, the stocks usually begin to fall right when their earnings are the best we see!
Big companies tend to act just like the rest of us when the winds of recession begin to blow -- they slow their spending as well, primarily on equipment and new buildings and real estate ... their big-ticket items.
This is where a crisis presents us an opportunity. We believe, If the economy continues to slow as we believe, cyclicals will continue to fall to prices we haven't seen in years. Our opportunity lies in the historical tendency for cyclicals to fall sharply going into a recession, and to rebound just as sharply once everything "quits getting worse." To state the obvious, extensive research and study is required so that we can avoid the companies that don't survive, but as I have expressed many times, this is as close to an idiot-proof investment as I have seen.
In the meantime we wait patiently (well, maybe not so patiently) with our cash and defensive stocks until we see signs that the selling may be over. Then we will begin to tiptoe back into our favorite cyclical companies ... an amazing opportunity if we time it right!
Don't Follow the Herd!
Please let us know if there is any way we can be of service to you. The team at Aspen Grove Asset Management aims to get better every day, and we want to use our talents to help make your life better, too. Let us know how we can assist you.
"Don't wait until you're in a crisis to come up with a crisis plan!"
-- Phil McGraw
This information does not purport to be a complete description of the securities, markets, or developments referred to in this material, it has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. This information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Every investor's situation is unique and you should consider your investment goals, risk tolerance and time horizon before making any investment. Any opinions are those of authors and are not necessarily those of Raymond James. Expressions of opinion are as of this date and are subject to change without notice. Past performance does not guarantee future results. Moody's Liquidity Stress Index measures the number of companies that carry Moody's lowest liquidity rating of SGL-4. It rises when more issuers are placed in that category, and it falls when liquidity rises. Past performance is not indicative of future results.