Good morning.

Okay folks, everything was taken down this week.  Stocks, industrial commodities, precious metals, bonds, the US dollar and, of course, oil!  I think I’ve added a few gray hairs since the last time all asset classes were taken down in a one week period.  Even the banks—oh my—were down this week.  Spooky.

The VIX wasn’t in-shape either.  Although the VIX still trades below 12, the index of options bets closed at the highest level of the year, at 11.66.

And before I delve into the analysis of this week’s market action, I must crow when I ‘get it right’, which, in the case of oil, I got it ‘spot on’.  As a friendly reminder of what was stated in my report of February 27, I dug up the exact quote for you:

…I view the oil market as vulnerable to a sizable downdraft as we approach May.  The stock performance of Exxon-Mobile (XOM) ranks at the very bottom of the list of DJIA 30 stocks, with a YTD performance of minus 10.17%.  XOM is telling us something, and I’m listening.  The oil market may soon be in trouble.  

And trouble we indeed witnessed this week in the oil market.  The WTIC price was slammed $4.84 this week, or a drop of 9.08%.  This ‘incident’ in the oil market this week underscores the importance of watching the price action of producers of commodities for signals relating to the commodity itself.  Since owning a stock is a leveraged bet on the underlying commodity, the shareholders of the industry leader are far sharper and informed than the speculators who dominate the trade in the commodity.

At $48.49 per barrel, WTIC now trades close to its 52-week moving average of $47.72.  I wouldn’t be at all surprised if WTIC drops further to $45 per barrel, with a huge base of support at $40 as the next level to consider a long play.  Inventory levels at Cushing, OK suggest to me a fair value of $45 per barrel.  However, pricing ‘overshoots’ are a regular feature of the oil market, so $40 is quite possible.

In the bond market, the US Treasury 10-year yield touched a post-election high of 2.60%, before dropping back a bit, to 2.58%.  This is the second-straight week of rising yields of the bellwether Treasury security.  A breakout above 2.60% might ring alarm bells in stocks, but I don’t expect the rate to climb much further, as I see renewed safe-haven buying in the data, which may include US Treasury securities in the coming weeks as a result of political uncertainty in Europe and fears of the Fed breaking something, as I’ll get into more in this report.

As for Friday’s job report this week, a 235k addition is heralded as good enough for the Fed to raise rates in the coming week.  Don’t fall for this malarkey.  Not only are the jobs numbers ‘fake news’, the traditional backdrop for the Fed to raise rates is not there, anywhere.    

John Williams of Shadow Government Statistics asked rhetorically in an interview with the NY Post, “How can GDP be in its 22nd quarter of expansion when industrial production (a major component of GDP) is in its 36th quarter of non-expansion?”  Williams says, the GDP picture, instead, rivals the economic statistics of Great Depression of the 1930s.  Here’s a chart I created to show John Williams’ point.

 

The blue line represents industrial production output.  Williams asks, how can GDP rise (red line) when industrial production is at the same level of 2008?  Consumer spending is the answer.  Right?  Well, how can consumer spending (green line) rising during a eight-year period of a labor participation rate at levels of the 1960s?  Credit, is the answer, and is also the “nitroglycerin on a bumpy road” when rates begin to rise during a period of high debt/GDP levels, according to Janus Funds Bill Gross.

[T]he global economy has created more credit relative to GDP than that at the beginning of 2008’s disaster. In the U.S., credit of $65 trillion is roughly 350% of annual GDP and the ratio is rising…Capitalism, with its adopted fractional reserve banking system, depends on credit expansion and the printing of additional reserves by central banks, which in turn are re-lent by private banks to create pizza stores, cell phones and a myriad of other products and business enterprises. But the credit creation has limits and the cost of credit (interest rates) must be carefully monitored so that borrowers (think subprime) can pay back the monthly servicing costs. If rates are too high (and credit as a % of GDP too high as well), then potential Lehman black swans can occur.

So, going back to my chart of GDP, industrial production and consumer spending, consumer spending rises cannot be a result of a five-decade-low US labor participation rate in the job market.  Williams and Gross are essentially stating that the US economy functions on purely cheap and risky credit (“think subprime,” Gross says).  So, what happens when rates rise?   

But our highly levered financial system is like a truckload of nitroglycerin on a bumpy road. One mistake can set off a credit implosion where holders of stocks, high yield bonds, and yes, subprime mortgages all rush to the bank to claim its one and only dollar in the vault. It happened in 2008, and central banks were in a position to drastically lower yields and buy trillions of dollars via Quantitative Easing (QE) to prevent a run on the system. Today, central bank flexibility is not what it was back then. Yields globally are near zero and in many cases, negative.

I’ve had LendingClub (LC) on my Watch List from time to time, and presently own it.  What has that company done to mitigate losses from high credit risk?  They’ve raised their threshold of who is a ‘qualified’ borrower.  Didn’t they?  Well, the Fed has done the opposite.  Rates are rising, by the Fed’s own hands, while the entire financial system is riddled with encouraged subprime debt, such as the hundreds of companies operating in the oil patch, as one instance, and those operating in the commercial real estate business, as a second instance.

Forbes Magazine write:

Commercial real estate loans as a percentage of total loans and leases at U.S. banks have slowly increased since 2008. These loans now make up 24.68% of portfolios, compared to 19.55% as of March 2008, according to data from Sageworks Bank Information.

With much lower oil prices suddenly appearing within a blink of an eye; commercial real estate loans making up more of US bank balance sheets; and a US economy driven purely via credit, while industrial production remains flat, the Fed is raising rates?

Zerohedge posts an article, entitled, Gundlach Says Fed Will Hike “Until Something Breaks,” Dumps Bank Shares.

Overnight [March 7, 2017], in his latest webcast to DoubleLine investors, Jeffrey Gundlach echoed Hartnett, when he said that he expects the Federal Reserve to begin a campaign of “old school” sequential interest rate hikes until “something breaks,” such as a U.S. recession.

Below, is a chart of financial events tied to Fed monetary policy.  From the chart, I can see each rate cycle reaching a level, at which point something breaks, has been lower and lower since 1980.  How high fed funds can go without creating a crisis is unknown, but it appears that the Fed is on its way to create another one.

 

So, what to do?  Albert Edwards has a strategy.

Make no mistake. Unlike most in the markets, I remain a secular bond bull and do not think this 35 year long bull bond market is over. I believe the US Fed has created another massive credit bubble that will, when it bursts, lay the global economy very low indeed.  Combine this with the problems of a Chinese economy dependent on increasingly ineffective injections of credit to produce increasingly pedestrian GDP growth and you have a right global mess. The 2007/8 Global Financial Crisis will look like a soft-landing when the Fed blows this sucker sky high. The seeds for that debacle have already been sown with the Fed having presided over one of the biggest corporate credit bubbles in US history.  All that is needed now is for the Fed to sprinkle life-giving rate hikes onto these, as yet dormant, seeds of destruction.  Accelerated Fed rate hikes will cause tremors in the Treasury bond markets, forcing rates up, most especially in the 2 year – just like 1994. But as yet another central bank-inspired global recession unfolds, I believe US 10y bond yields will ultimately converge with Japanese and European yields well below zero – in other words, buy 10y bonds on weakness!

So, that’s my thinking this week.  I expect some higher volatility the coming week, so stay long stocks, and hedged!  

Also, take a look at the gold/copper ratio.  It might be time to play a widening between the dollar-gold pride and copper price.  That’s a trade involving going long gold (GLD) and short copper (JJC).  

And a long trade in the Treasury 10-year note Exchange Traded Fund (IEF) may make sense very soon, too.  I agree with Gundlach’s and Edwards’ expectations of the US Treasury 10-year yield moving back down.  Gundlach speculates 2.25% will be the bottom in the US 10-year rate in this present cycle.  I cannot argue with Gundlach’s target rate, but agree more strongly with Edwards’ assessment in the longer term.  Yes, the US Treasury may reach zero bound as long as the globe accepts this insanity from the custodians of the world’s premier reserve currency!

If I’m right, the accelerate the demise of the petrodollar system would most likely propel dollar-gold, dollar-oil and dollar-commodities much higher in price.  Hmm.  What would the world look like then?

Okay, let’s talk about the stocks I’m watching now.  

This Week’s JBP Stock Ideas

There were no trades this week.  I’m holding five positions, and may sell any stock at any time in exchange for a better proposition.  But, I beat the Russell 2000 drop of 2.07% this week, thanks in large part from great moves in LQMT, LC and ANGI, and that’s a good indication of a collective relative strength in my five holdings.

I’ve add a new and interesting potential play to the Watch List: Castle Brands, (ROX)

My current portfolio: LQMT, CROX, LC, ANGI and GRPN

MY WATCH LIST

SIENTRA (SIEN)

Sientra (SIEN), a maker of silicone breast implants and a budding successful turnaround story from an unfortunate factory stoppage at its third-party manufacturing facility in Brazil, Silimed Industria de Implantes Ltd.  A little more than a year ago, due to a European regulatory agency issuing a marketing suspension of all products made at the Brazil plant, after flaws were found in some silicone implant products made at the facility, trouble came to Sientra, but through no fault of theirs.  

Although Sientra manufactured implants at the plant employed production standards approved by the US FDA, and were independent of other processes at the facility, Sientra voluntarily suspended operations in September 2015 until a third-party inspector verified Sientra’s implants were not among those produced by the methods of other Silimed customers exporting to the European market.  

Following the news of Sientra’s voluntary production suspension, the share price of SIEN crashed to as low as $3.34 by mid-November, from a high of $26.67 reached in late-June.  

As a result of the work stoppage, Sientra’s revenue plummeted in Q1, Q2, Q3 of this year to a fraction of the company’s Q3 2015 peak sales performance.  But since the stock’s November low, SIEN is coming back steadily following an announcement in early-February 2016 that stated the Brazilian plant is again operating and shipping product.

Previous customers who suspended orders to Sientra are coming back to the company, who, at the height of Q3 2015, supplied between 7% and 12% of all implants to a US market, with estimates ranging from $200 million and $300 million per year of revenue, and growing.

On December 5, 2016, SIEN soared to as high as $10.22 (27.6%), following a news release by the company of an FDA pre-market supplement (PSA) approval for the company’s four new implant styles and shapes.  These new products will be added to its present line of nine offerings.  The company expects to begin delivery of the four new implant in Q4 2017.

My take: I like the stock for its hidden future trend of higher revenue, as the results of a survey conducted by the company of the customers affected by the work stoppage at the Brazilian plant indicated that nearly all customers expect to order Sientra products again when they become available.  

And there is a good reason for this nearly-perfect positive response.

First, Sientra is the only company of the three operating in the US (the other two: Mentor, Natrelle) who offers a two-year guarantee against ‘capsule contracture’, an issue of primary concern of most patients and surgeons.  Sientra’s rate of contracture is, indeed, the lowest of the three makers.  And the company also hold the distinction of offering implants with the lowest in incidents of rupture.

This is a big deal, as far as I’m concerned.  Imagine if you were undergoing an implant procedure.  Wouldn’t you want an implant with the highest reputation of product safety?  Of course, you would.

Second, patients report that Sientra implants feel more natural, which is definitely another big win for Sientra.

In short, Sientra’s implants are best of breed, which weighed heavily on my decision to engage this stock.  I expect revenue to regain the $10 million-plus per-quarter level.

Read Sientra’s Quick Fact Sheet

ABOUT SIENTRA

Sientra, Inc., a medical aesthetics company, develops and sells medical aesthetics products to plastic surgeons and patients in the United States.  The company offers a portfolio of silicone gel breast implants for use in breast augmentation and breast reconstruction procedures; and breast tissue expanders.  It also provides body contouring and other implants, including gluteal, pectoral, calf, facial, nasal and other reconstructive implants.  Sientra, Inc. was incorporated in 2003 and is headquartered in Santa Barbara, California.

Source: Finviz.com

CASTLE BRANDS (ROX)

If you’ve been watching the wire, you’ll already know that ROX is the latest hot small-cap stock on the NYSE, following a February 28 announcement that it had inked a deal with Walmart to supply 4,500 stores with America’s no.1 ginger beer brand, Goslings.  As of March 1, Goslings Stormy Ginger Beer and Goslings Stormy Diet Ginger Beer are available on the shelves of approximately 40% of Walmart’s entire chain.

On the day of the announcement, the share price of ROX soared to as high as $1.45, from an opening price of $0.72, a 101.3% spike.  The stock has since succumbed to profit-taking, and now trades at $0.99.  The 200-week moving average has served as a magnet for the stock, as on the day of the announcement the stock violently traded in a broad range, yet closed at the 200-week moving average.  This week, the 200-week moving average was once again a wall for the stock.

Given the comparative market capitalization of the company against its competitors (much larger, too), the stock may easily reach $6 per share, if Wall Street begins to price the stock closer to the company’s industry peers.

VERY INTERESTING, INDEED

And here’s a bit of interesting information that makes my heart warm over.  “The Warren Buffett of Biotech,” Dr. Phillip Frost, has taken a 33.5% stake in ROX.  What?  

This billionaire septuagenarian believes ROX is grossly undervalued.  And when I delineate the company’s vitals, you’ll see why this stock is on my Watch List.  Remember, I have five stocks in the frying pan, and will be thinking of this stock each night.    Here’s a link to the Forbes article about Frost and his 20 stock picks.  You’ll see ROX among the list of stocks he owns, and the stake he has in the company.

Forbes Magazine: The Buffett of Biotech’s Portfolio

Here’s why I like the stock, and expect power moves higher in the future, taking out the overhead resistance at the 200-week moving average at approximately $1.00.

• Revenue growing at CAGR of 20.5% since 2013, and accelerating.  In 2016, revenue rose 25.7%.  Gross margin has increased each of the past four years.  Operating profits and net income have increased in each of the past four years.  Very strong balance sheet.

 

• Consistently grown core brands faster than industry average
• Directors and officers own approximately 41% on a fully-diluted basis
• Shipments of Jefferson’s Bourbon increased 45% to 61,000 cases in fiscal 2016, compared with 42,000 cases in fiscal 2015.  Shipments of Goslings Rums in the U.S. increased 8% to 135,000 cases in fiscal 2016, compared with 125,000 cases in fiscal 2015.  Shipments of Goslings Stormy Ginger Beer increased 56% to 1,115,000 cases in fiscal 2016, compared with 715,000 cases in fiscal 2015.
• Castle Brands holds an exclusive market agreement for Goslings brands in the United States.  Agreement with Walmart for the United States’ no. 1 ginger beer, Goslings Stormy Ginger Beer and Goslings Stormy Diet Ginger Beer, is a monopoly.   
• Publicly-traded drinks companies trade between 5x and 6x revenue, and 16x and 20x times EBITDA.  ROX trades at only 2.38x revenue.  Castle Brand’s closest competitor (by revenue), Remy Cointreau (RCO:FR), trades at 4.28x revenue and 22.7x EBITDA.

Frankly, although ROX has recently gained attention on Wall Street, this stock is grossly depressed at even the $1.00 level.  I’ll be watching the action in ROX, especially if/when it clears the 200-week moving average.  

Earnings won’t come out until mid-May, at which time I expect fireworks.  In the meantime, I’ll be watching this stock closely, as I may take a position in ROX at anytime between now and early-May, the latter time of which I expect a ramp up in the stock price as we approach earnings within approximately two weeks.  

Castle Brands will have one month of sales to Walmart reflected in Q1 revenue, so I (and the world) will be able ascertain whether to continue holding the stock (based on the assumption I buy the stock before earnings) as a long-term play, or not. Currently I’m long ROX as a swing trade at $1 and will likely buy 10,000 shares above $1 sometime this week as a multi-month long-term play too.

And here’s a bit of interesting information that makes my heart warm over.  “The Warren Buffett of Biotech,” Dr. Phillip Frost, has taken a 33.5% stake in ROX.  What?

This billionaire septuagenarian believes ROX is grossly undervalued.  And when I delineate the company’s vitals, you’ll see why this stock is in my portfolio as of last week.  Remember, I don’t have many stocks in my frying pan, and will be thinking of this stock each night. Here’s a link to the Forbes article about Frost and his 20 stock picks.  You’ll see ROX among the list of stocks he owns, and the stake he has in the company.

Forbes Magazine: The Buffett of Biotech’s Portfolio

Until next time…

Trade Wise and Green!

Jason Bond