China finally hit the fan last week, resulting in the worst opening week of trading in history. The Dow Jones Industrial Average dumped 1,079 points (6.2%) to close at 16,346.45. The S&P 500 collapsed by 122 points (6%) to end the week down at 1922.03, and the Nasdaq Composite Index plummeted by 363.78 points (7.3%) to 4643.63.
The MSCI World Index lost 6% as markets around the world joined in the disaster – led by China, where stocks fell so quickly that regulators shut them down on Thursday after a mere 29 minutes of trading. Then they realized that doing so only made matters worse.
While the major U.S. market averages are flirting with a 10% correction, the reality is that most of the market is already trading in bear market territory. The average S&P 500 stock is down 22.6% according to Bespoke Investment Group.
Even the so-called FANGs took it on the chin this week, led by Amazon.com, Inc. (Nasdaq: AMZN) with a 10.2% drop. Alphabet Inc. (Nasdaq: GOOG) lost 5.9% and Facebook, Inc. dropped 7%. Netflix Inc. (Nasdaq: NFLX) managed to lose only 2.6% after announcing expansion into more markets. But the carnage was widespread and nobody was spared.
Oil prices continued their collapse with another 10% decline to $32.88 per barrel for WTI Crude. The week opened with Saudi Arabia and Iran at each other's throats, and the normal formula for Mideast tensions to push oil prices higher. But instead, the struggle between the Saudis and Iranians for Middle Eastern dominance means that both countries will increase their oil production and push oil prices lower.
Oil is heading into the $20s and will stay depressed for longer than people anticipated. This means, among other things, that more U.S. frackers will file for bankruptcy in the near future.
The Credit Cycle is Destroying This Sector
Other sectors of the stock market are showing serious strains. The large, public private equity firms have seen their stocks cut nearly in half – The Blackstone Group (NYSE: BX), KKR & Co. (NYSE: KKR), Ares Capital Group (NYSE: ARES), Apollo Management (NYSE: APO), and The Carlyle Group ( Nasdaq: CG). The bad news is that these stocks are likely to decline much further as the credit cycle continues to bottom for at least another two years. These stocks will become very attractive buys at some point but should be avoided for now.
Another disaster is unfolding among Business Development Companies (BDCs), some of which are associated with private equity firms. BDCs are non-bank lenders that loan money to small and mid-sized companies, many of which are owned by private equity firms. Recently, Congress decided to allow them to increase their leverage and lend to financial companies – a world-class bad idea.
One of these companies, Prospect Capital Corp. (Nasdaq: PSEC) was recently in the news for its poor returns and the egregious management fees it is paying to its executives. PSEC should be avoided by investors at all costs. Virtually all of these companies are trading at sharp discounts to their net asset values due to concerns about deteriorating credit quality since the companies to which they lend are among the lowest quality credits of the junk bond universe.
BDCs are another trouble spot to avoid as the credit cycle deteriorates despite their high dividends. These companies are going to have to cut their dividends and their stock prices are going to decline further as they begin to report higher loan losses.
No Rest for The Cheerleaders
This morning, Barron's was naturally filled with articles quoting the usual suspects – like the terminally bullish Tom Lee of Fundstrat Global Advisors (you can often find him chirping away on CNBC about how the market is going to go up) and Nuveen's chief investment strategist Bob Doll – about how investors should remain calm because stocks are still the best game in town. These are the same people who are always telling investors to invest in stocks.
Mr. Lee was calling for the S&P 500 to end 2015 at 2350 and told CNBC that there was a 5-to-1 chance that the S&P 500 will rise in 2016. Mr. Doll is paid to attract money to Nuveen's funds. Their advice is worthless. Telling people that stocks are the best game in town is like saying that the lifeboats are the safest seat on the Titanic. The markets are tanking. China is a ghost ship. The U.S. economy is in trouble. We are in a bear market.
It is time to reduce risk, sell your stocks, ignore the pundits (idiots in sheep's clothing) and save yourself. I will tell you when it's safe to go back into the markets…I have nothing to sell you but my reputation, which I've earned by telling the truth for the last two decades.
It hasn't gotten me invited to any White House dinners, but it has allowed me to look myself in the mirror every morning and like what I see.
About the Author
Prominent money manager. Has built top-ranked credit and hedge funds, managed billions for institutional and high-net-worth clients. 29-year career.