Peloton’s 2016 Q1 Recap

A Poor Start to 2016

To say that stocks got off to a poor start in 2016 is putting it mildly. Dragged lower by collapsing oil prices, the S&P 500 posted its worst 10-day start to the new year ever. Yes, EV-ER. Despite the indigestion caused by a 9% drop in two weeks, we were adamant that not only is panic the wrong reaction but that the drop was altogether irrational because lower energy prices are actually good for much of the economy.

Markets didn’t agree. Rather than focusing on the profit tailwind, investors chose to fixate on the possibility that lots of over-leveraged energy companies would go belly up and upend the banking system via massive loan defaults. At the time, this also seemed irrationally pessimistic to us.

Comparisons to the residential mortgage crisis are ridiculous because the exposure at the biggest banks (like B of A and Wells), is less than one tenth of what it was leading up to 2008. Mortgage loans made up roughly 25% of loan portfolios before the crisis. Loans to oil and gas companies comprise about 2% of loan portfolios today. Banking analyst Mike Mayo put it in perspective in January when he said, “You could easily write off every dollar in oil and energy loans and have more capital than before that last crisis. Banks have enough cushion.”

Since then, several large energy companies have filed for bankruptcy, including Peabody Energy, which was at one time the largest coal company in the U.S. There will probably be more as the weak and over-extended players are shaken out. However, in the short-term, it appears that oil prices bottomed in the mid-$20s roughly two months ago. Since then, oil has rebounded 50%, and the S&P has gained 13% in eight short weeks. The NASDAQ index is up more than 15% over that period. In fact, the S&P 500 erased the early deficit and posted gained 1.4% for the quarter. Other indexes have also recently turned positive for the year.

What’s to Come

None of this is to declare victory or suggest all smooth sailing ahead. But it does, yet again, illustrate the danger that short-term volatility presents for emotional investors. When you give up 13% once, it stings. Do it three or four times, and that’s real money lost. This market has given investors abundant opportunities for shooting oneself in one’s foot. Peloton stresses discipline and process to avoid emotional investing mistakes.

We still think the broad market is fairly valued, which provides a neutral climate for thoughtful and analytical stock picking. Corporate earnings for most corporations will continue to benefit from energy cost savings, but if we had to guess, oil price equilibrium is probably still 25-50% higher ($50-60 per barrel versus $40 today). Markets will continue to be volatile as election rhetoric ramps up. Expect particularly large swings in the areas being targeted most aggressively by the candidates, which includes all Healthcare companies and any other company that tries to make money for its shareholders.