Growing Sense of Calm

The extraordinary 15-minute selloff in US stock I discussed last week in the Flash Alert Don’t Panic has been redubbed the “Flash Crash” by the mainstream media.

Along with a catchy name, the weekend yielded more concrete explanations of what caused the sudden, precipitous decline in US stocks. Some large sell orders in S&P 500 futures hit a long list of stocks that trade on the New York Stock Exchange, activating temporary curbs that slow the pace of trading. When that occurred, electronic volumes shifted to various other electronic trading networks; these alternate trading venues were overwhelmed by the volume and couldn’t provide reasonable liquidity. 

Many questions remain about what transpired, but one thing is certain: The market action was neither reasonable nor normal. Many stocks traded to levels that don’t reflect fundamental realities. Ultimately, I suspect the major exchanges will agree to new rules aimed to prevent future incidences; a second Flash Crash would deal a serious blow to the exchanges’ reputation for credibility and transparency.

A comprehensive plan out of Europe over the weekend to defend weaker EU members and provide liquidity to the banking system will also halt many of the concerns that ran rampant last week.

The near $1 trillion EU plan will help to calm concerns going forward. The S&P 500 finally suffered the 10-percent correction–a welcome development given the market’s nearly uninterrupted rally over the past several months. It’s possible the broader market will retest of recent lows, though it’s more likely to trade sideways within a range. I suspect the worst of the selloff has passed. 

Nevertheless, many individual investors took a hit during the Flash Crash because stop-loss orders–orders for a broker to automatically liquidate a position at a predetermined price–were activated. I support the use of stops as a risk management technique even though that resolve is sometimes tested by stocks that stop out only to reverse course. Over time the profit foregone on stocks reversing prior weakness is more than offset by stocks that trade through your stop and keep heading lower.

The magnitude and speed of the Flash Crash was unprecedented; there was no way to predict such an event. However, the stops recommended in The Energy Strategist worked rather well. Given the increased market volatility of recent years, I advised against setting stops on the least liquid recommendations. This includes master limited partnerships (MLP) and other groups that have a history of extreme moves in fast markets. This policy saved us from being stopped out of Linn Energy (NSDQ: LINE) and Enterprise Products Partners (NYSE: EPD).

With some of my recommended MLPs now trading back under my buy targets, it’s a good time to buy.

Despite these measures, we still had a few recommendations breach their stops on Thursday and Friday: Eni (NYSE: E, Italy: ENI), Occidental Petroleum Corp (NYSE: OXY), Delta Air Lines (NYSE: DAL) and Petrohawk Energy Corp (NYSE: HK). Some data services indicate that Petrohawk did not breach our recommended stop, while others trading to an intraday low of $13.90; for purposes of returns, we’ll assume the stock breached our stop.

The bottom line is that with the exception of Delta Airlines (NYSE: DAL) these stop-outs do not reflect the fundamental performance of any of these recommendations.

In the March 24 issue Investing in Efficiency, I cut my recommendation on Delta from a buy to a hold and tightened my recommended stop to lock in about a 50 percent gain. Shares of Delta Airlines touched that stop; I recommend you take that 50 percent gain. Profits for Delta should be reinvested in Spirit AeroSystems (NYSE: SPR), a stock I analyzed in the March 24 issue.

Petrohawk is traditionally regarded as a gas producer but its focus on the Haynesville Shale is a huge positive; the deposit among the cheapest-to-produce gas fields in the US. Meanwhile, the producer has a major presence in the Eagle Ford Shale in southern Texas, a liquids-rich play.

Petrohawk’s exposure to natural gas liquids (NGLs) and oil production means that it’s earning far higher value for its production than most assume–I explain this concept in the April 28 issue of The Energy Letter Why Some Natural Gas is Worth $7.28.

Moreover, it’s worth noting that even at the height of last week’s carnage, natural gas prices held up surprisingly well as did many gas-levered stocks. Natural gas is trading higher today than it was a week ago, but the same can’t be said for oil, copper or any other commodity you’d care to examine. Petrohawk Energy Corp rates a buy under 30 with no stop for now.

Eni is a major integrated-oil company based in Europe. Its shares were harder hit than those of US-based energy firms–likely because Europe was the epicenter of the recent crisis. Eni rates a buy under 52; we’ll suspend this stop for now.

Finally, Occidental Petroleum is an oil-focused producer and is the most disappointing stop-out of all, as fundamentally the company continues to fire on all cylinders.