We're not going to sugar-coat it, this was another painful week in the market. The S&P 500 dropped 2.2%, bringing the year-to-date fall-off to 8.0%. A number of factors weighed on the market, including slowing global economic growth, the sharp drop in oil prices, continued currency headwinds, higher costs year over year (minimum wage and health care), sovereign fund issues plus a number of billion-dollar hedge funds that are being unwound. As we look toward a shortened trading week that is in many ways the real kickoff to December-quarter earnings season, it's not all that surprising to see investors taking risk off.
At best, we see the stock market moving sideways through earnings season, but more likely to come under additional pressure as expectations continue to be reset. When we say "expectations" we mean those for global growth, oil prices, corporate earnings and so on. You've heard us talk more than a few times about the aggressive 2016 earnings estimates for S&P 500 companies this year, and the revisions lower we've been expecting have only just begun.
We've heard from several subscribers and understand the frustration with the market thus far in 2016. Candidly, we are as frustrated as you are given the current environment where even good news seems to fall on deaf ears. Much like a medical professional, one of our objectives is to cause no harm and from time to time that means making changes to limit losses and preserve capital, particularly as things change.
Are we happy when we decide to throw in the towel on a trade? No, and it's never a decision we take lightly. This week, we decided to exit several positions -- Illinois Tool Works (ITW), Harman International (HAR), G&K Services (GK), V.F. Corp. (VFC) and Ulta Salon (ULTA). In some cases, we booked nice gains, while in others we opted to limit losses, but the bottom line is we were striving to be prudent stewards of capital ahead of what looks to be a messy earnings season.
That's also why we've been prudent in putting capital to work over the last few months, preferring instead to build cash as storm clouds grew that have since become the current situation. That cash not only offers us flexibility for when things eventually settle down, but it also serves as protection in the storm.
One of the big drivers of the market selloff this week has been oil. Oil prices have continued to come under pressure given the growing oil glut, reflecting the weaker demand witnessed not only in December PMI data from Markit Economics and the Institute for Supply Management but a lackluster Fed Beige Book. Brent oil prices fell following data that showed crude inventories rose 234,000 barrels last week, but the real hammer to oil was the build-up of 8.4 million barrels in gasoline and over 6 million in distillates, which includes diesel and heating oil. We can thank the El Nino-inspired warm temperatures that have been plaguing retailers since October, which also curtailed utility activity during these months.
Keep in mind we have yet to feel the effects of Iran returning to the oil export market, and with OPEC waving off an emergency meeting despite requests from several members amid the continued slide in oil prices we do not expect OPEC production cuts anytime soon.
All this has us expecting oil prices will remain significantly lower year over year, which while good for the consumer, will likely lead to reduced earnings expectations, capital spending cuts and, in all likelihood, some degree of industry consolidation in the coming months.
This also raises a key issue that the stock market is grappling with today. With oil near $30 per barrel, James West, an energy industry analyst at ISI Evercore, says months of low activity have left many of the companies in the hydraulic-fracturing business either insolvent or close to it. West sees as many as one-third of the fracking companies going bust by the end of 2016. But here's the issue: there's about $300 billion in high-yield bonds in the industry that will need to be restructured.
Friday morning, BHP Billiton (BHP) said it will book a $4.9 billion after-tax impairment charge against the value of its U.S. shale assets to reflect its reduced projections on prices and revisions to its own development plans. We see this as just the beginning. That mess is already spilling over into big oil, with British oil giant BP (BP) announcing it would eliminate 4,000 of the approximately 24,000 positions in its exploration and production units this year.
Royal Dutch Shell (RDS.A), BP's biggest European rival, already cut 7,500 jobs last year with another 2,800 likely to happen when it completes its acquisition of the BG Group, a producer of oil and natural gas based in England. We doubt we have seen the last of this and its impact on expectations.
In this current market environment, managing risk becomes crucial. Even the best, most disciplined investment managers know when it is time to say "uncle" on a trade -- and as you saw this week, we're not afraid to admit when it is time.
The good news is that while we've struggled to find much that is attractive, the current market correction is finally moving us toward a place where stocks are not so richly valued, particularly in a struggling economy. In the coming days and weeks, you'll see more companies added to the Trifecta Bullpen as we build our shopping list for when the market finally settles down.
Hopefully next week will be a smoother one, although we would not be shocked to see the volatility continue given the earnings on deck. We'll continue to be patient and prudent with the portfolio.