Coal Miners: On Sale?

The S&P500 inched up only 0.6%c last week on moderate volume. Volatility, as measured by the VIX, slipped almost 11%. Several breadth indicators continued to deteriorate. The summation index, for example, dropped further, as did the percent of stocks above the 150 day moving average. The bullish percentage index also dipped, and the weekly flow of retail funds continues to show a seemingly never-ending move from stocks and into bonds.

Almost every macro news announcement missed expectations. The exception was retail sales which rose slightly more than consensus (for sales ex-autos). Almost everything else was a disaster. Empire State manufacturing plunged. Housing starts came in far below expectations, as did existing home sales. Industrial production was supposed to rise 0.3%; instead, it showed zero growth. Initial jobless claims spiked again, this time to 386,000—well above the consensus of 365,000. Finally, the Philly Fed survey missed badly.

Technically, the S&P500 is moving into a wedge formation where, in the near term, stocks ought to break one way or another—decisively. They’re coiling for what could be a big move. The breakdown that started in early April has damaged many of the four-month bullish trendlines and it wouldn’t be surprising if the big move were a continuation to the downside, where last week we saw the formation of a bearish flag (or counter trend bounce that reverses itself quickly). The next week should be telling.

But while most of the major sectors in the S&P500 are still near their multi-year highs, highs attained courtesy of the Fed’s continuing liquidity programs, there have been a few notable breakdowns.

First, the market darlings. Priceline and especially Apple have been the strongest market leaders, or “generals”, paving the way for gains in the broader market over the last four months. But over the last two weeks, these two leaders have broken down…..badly. Priceline is off almost 8% from its recent highs, and more importantly, Apple is down 12% from its highs. Given how important these two are to the broader markets, this is not a good omen if their sell off continues next week.

Second, the coal miners have now fallen to lows last seen during the general market meltdown in late 2008 and early 2009. Large, well capitalized coal miners, that generate strong cash flows—such as Peabody Energy, CONSOL Energy, and Alpha Natural Resources—are on offer today at prices 70% to almost 90% below their 2008 highs. And unlike natural gas, which is falling to decade lows due to seemingly endless inventory builds (mainly because of a new drilling technology called fracking), coal is still in relatively limited supply, difficult to get out of the ground, and needed for the majority of US and global electricity generation. Simply put, there’s very little risk of coal being substituted or replaced in the next few years.

So while several key market leaders are cracking, a deep value opportunity is presenting itself in the coal mining industry. Make no mistake, these stocks could fall even further from their current low prices, but buying near today’s bargain price points could offer a solid margin of safety as well as the prospect of strong returns in the future.

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