Another Bear Market Warning
Another bear market warning... Bull market 'darlings' are still falling... More signs of a slowdown... More 'backtracking' from the Fed...
One of the biggest potential signs of an impending bear market is seeing the stocks that led the bull market higher – so-called bull market "darlings" – reverse and move lower.
In every bull market, there are a handful of these companies that capture the imagination of the investing public... driving the market higher and higher as they soar to ridiculous valuations.
Then when the market turns, valuations plummet as the excitement wears off and investors wake up to reality.
As regular Digest readers know, two of the biggest stories of this bear market have been privately held "lab-testing" company Theranos and electric-car maker Tesla (TSLA). And both of these companies have run into serious trouble recently...
Last fall, reports began to emerge that Theranos was not all it was "cracked up" to be. As Porter explained in the October 30 Digest...
Here, a very attractive, young, tall, lithe, blonde woman who dresses exactly like late Apple founder Steve Jobs has been peddling a "miracle" technology that can render hundreds of different blood tests from patients, at almost no cost, without using a needle. These claims led to a private market valuation for her business of $6 billion. If she had been able to go public, that valuation number would have surely gone even higher...
There's only one slight problem: There hasn't been any "peer-reviewed" testing of the technology. Instead, many of her employees told the Wall Street Journal that it doesn't work. They say almost all of the testing is done with standard "venous" blood draws. Somehow, these facts and her Halloween-costume-like appearance didn't tip off any of the venture capitalists.
The news has only gotten worse since then...
Last week, inspectors from the Centers for Medicare and Medicaid services ("CMS") reported finding "deficient practices" at one of the company's labs that "pose immediate jeopardy to patient health and safety."
According to the Wall Street Journal, the letter described "five major infractions" at the lab, including one that was "likely to cause, at any time, serious injury or harm, or death, to individuals served by the laboratory or to the health and safety of the general public."
Theranos was given 10 days to come up with a legitimate plan to fix the problems. If it can't, CMS could revoke the company's certification – which is required to do any human lab work – and fine the company as much as $10,000 a day.
In the meantime, drugstore chain Walgreens (WBA) – the company's retail partner – has already temporarily closed its Theranos Wellness Center in Palo Alto, California. It said it will also no longer send patient blood samples from its pharmacies to that Theranos lab.
According to the Journal, Walgreens would not comment on the matter, except to refer to a previous statement in which it said it is "currently in discussions about the next phase of our relationship."
Losing that relationship would be another huge blow for Theranos. The partnership accounts for the majority of the company's sales to the public.
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Likewise, the news has gotten much worse for Tesla...
We've documented many of the company's problems several times, so we won't rehash them all here. But last Monday, analysts at JPMorgan slashed their estimates for the company's fourth-quarter earnings.
The analysts cut their earnings forecast by more than half – from $0.26 per share to just $0.10 per share – after reports that the company is selling fewer of its new Model X SUVs.
They explained the move by noting that they expect the "the slower-than-expected ramp in Model X vehicle production will pressure gross margin." JPMorgan currently holds a $180-per-share price target on the stock.
The stock fell more than 3% that day to $196.38. This is down from a peak of more than $280 a share in July...
Unfortunately, this week brought even more bad news...
Yesterday, Morgan Stanley analyst Adam Jonas – considered one of the biggest Tesla "bulls" on Wall Street – also cut his estimates...
Like the JPMorgan analysts last week, Jonas noted the slower-than-expected deliveries of the Model X...
We understand our forecasts for Model X volume are well below expectations – a position we believe is appropriate until Tesla can provide greater assurances and proof that it can manufacture and deliver this model at high scale and with high quality.
He also reduced his long-term total delivery forecast to less than half of Tesla's 500,000 projection for the year 2020.
Jonas cut his price target from $450 to $333 (we did say he's a Tesla bull). Shares were down another 7% as of midday trading to around $182 per share today.
Tesla will announce fourth-quarter earnings after the market closes on February 20.
Finally, it appears the Federal Reserve is stepping even further away from increasing interest rates again this year...
As we've discussed, last month at its December meeting, the Fed voted to raise short-term interest rates by 0.25%. It also predicted that it would likely raise interest rates three to four more times in 2016.
But in comments to CNBC yesterday, Federal Reserve Vice Chairman Stanley Fischer said the Fed is now worried that the recent market turmoil could interfere with that plan.
Later in the day, in a talk at the Council on Foreign Relations in New York, he explained further...
At this point, it is difficult to judge the likely implications of this volatility. If these developments lead to a persistent tightening of financial conditions, they could signal a slowing in the global economy that could affect growth and inflation in the United States.
But Fischer didn't stop there. He also suggested the Federal Reserve could even reverse the recent rate increase if necessary. He also hinted that some officials at the Fed could now be seriously considering negative interest rates for the first time. In particular, he said that negative interest rates in Europe (and now Japan) are "working more than I can say I expected in 2012."
As always, we don't pretend to know what crazy ideas the "Ivory-tower" academics at the Fed may try next.
But we would note that even after the recent rate increase, short-term rates are still sitting between 0.25% and 0.50%. Cutting them back to near zero or slightly below is unlikely to pack the same "punch" as previous rate cuts. And a move into negative territory could have unexpected consequences...
It would likely hurt earnings in the financial sector, which is already struggling and lagging the market in recent months. It could also increase volatility further if the market believes the Fed is less "in control" of the situation than previously believed.
In other words, expecting the Federal Reserve to step in and "save" the market this time may be asking too much.
New 52-week highs (as of 2/1/16): McDonald's (MCD), Public Storage (PSA), short position in Santander Consumer USA (SC), Constellation Brands (STZ), and Sysco (SYY).
A busy day in the mailbag... More comments on the Flex Alliance, praise for Porter's latest Friday Digest, and more feedback on our short-selling recommendations. Send your questions and comments to feedback@stansberryresearch.com.
"Dear Porter et al, As a new Flex subscriber, I could not agree with you more – the intent is plainly, 5 products at any one time, with the flexibility to occasionally alter the mix. It seems that either common sense or basic ethics have escaped some people and this truly is a stunning insight into human behaviors.
"Unfortunately one cannot assume anymore that certain individuals' thinking are in-line with the matter at hand--namely, in this instance, that the flexibility is akin to periodic portfolio-balancing or strategic shifts in investment focus. You are correct: in a certain part of the world, this rogue behavior is referred to as 'taking the piss'... trying to take obvious advantage which is not the spirit of the agreement.
"The common-law world legitimately recognizes the litmus test of 'reasonableness' – applying both to this behavior; and also to your new once-per-month rule. A shame we have to contend with idiots like this because they always introduce complications for everyone else; but the sweet irony may be that these people, in frantically sweeping their greedy arms to scoop all the chips from the table, likely lack any modicum of focus in their financial lives and hence won't benefit anyway." – Paid-up subscriber Mike Lohmann
"Hi Porter, I am a Flex Alliance member and I think you are being more than fair. Multiple switches per quarter clearly violates the intent of the deal. Cheers." – Paid-up subscriber Paul
"I have to admit, that I rarely have ever found a more brilliant essay on current world energy/economic problems than yours [in the January 29 Digest]. The final conclusion, that this is not a mere correction of inflated stock prices but a creative destruction – chapeau – that is Schumpeter at his best. Congratulations." – Paid-up subscribers Elfriede & Peter K.
"Excellent article on the domino effect of the credit crisis. I doubt if many of us had taken the time to think through all the inter-connectedness of such a wide variety of the various industries. Thanks Porter. Keep up the good work." – Paid-up subscriber Manning
"It seems that I write this kind of thing so often. Over the years the value of what I get from Stansberry always amazes me. But this particular Digest struck me in an interesting way. Because of all that I have read over the years I knew the material that was within. But when you read how someone else tells it you realize that you have become well educated because of all of the years that you have been with Stansberry.
"I sent a note to Doc about my starting to trade options. I have done 6 trades of selling puts. The last two of those trades with real intent rather than just because I can. But on the trades that I made with intent I am realizing why you can make so much money trading options. Sure I was told that many times over the training that I have taken. But when you are doing it yourself you realize that you can make so very much money without much risk. Doc's method is most amazing when you actually do it.
"I am looking forward to reading the lifeboat material. This will give me the tools to go through a bear market in style. I have everything in place to do it so I am ready. But based on all that I have read over the years from all of you it will give me much greater depth and wisdom." – Paid-up subscriber Jeff S.
"Porter – IT'S OFFICIAL. I am now a 2016 Level II candidate in the CFA program. It was your letters and your letters alone, that led me down this path. I couldn't be more thankful. I hope to repay you someday. Or at the very least, pay it forward. P.S. My clients silently thank you as well! Perhaps when I finish I'll send a resume..." – Paid-up subscriber Shane F.
"Yes, I did take Porter's advice! I purchased an April 15 put option on Santander @ $114 on 12/16 and today it closed at $370 for a $256 gain = 224.5%!! – so far! I only wish I had purchased more, but the advice was excellent – Thank you. I'm warming up for the potential bond debacle ahead this year!" – Paid-up subscriber Larry A.
Brill comment: We're glad you're doing well on your trade, but we want to point out that Porter recommended shorting shares of Santander Consumer USA (SC). He didn't recommend buying puts.
In general, consistently making money as a buyer of put options is much more difficult than simply shorting shares.
You not only have to be correct about the direction of a stock's move, but you also have to get the timing and "distance" – how much higher or lower the stock moves – right, too.
As your example shows, it's not impossible... But if you're going to buy puts, you must be disciplined. An option loses more and more value over time as its expiration date gets closer, and many expire worthless. (This is just one of the benefits of the option-selling strategies we've been discussing... Time is working for you, rather than against you.)
This means you must keep your position sizes small, and only buy them with money you're willing to lose.
The problem is many folks – especially novice investors – will get lucky and hit a "home run" or two early on. Suddenly, they stop thinking about risk management... and start imagining how much more money they could make if they bought a few more.
Unfortunately, most folks eventually learn this lesson the hard way... when a large portion of their savings vanishes virtually overnight.
Regards,
Justin Brill
Miami, Florida
February 2, 2016
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