Why a Market Correction Can Be A Very Good Thing (ENSV, PFIE, APT, LAKE, NETE, NXTD)

I’ve said it in the past and I’ll say it again: it’s impossible to predict the precise end of a bull market. In fact, over the past two months, we’ve seen wild market swings to the downside, which has pundits saying the gig is up, followed by unexpected and powerful rallies signaling more life for the bull run.

Here’s what we know for sure: the big three U.S. equity indexes have faced some tough sledding in recent weeks. A spate of bad international developments — ISIS, a jittery European economy and Ebola — has taken its toll on investor enthusiasm for U.S. equities. Couple that with falling oil prices, a Russell 2000 index that is already in correction territory, and a widely-held view that at the very least the markets have become overextended, and conditions are ripe for a significant market pullback.

Personally, I’m not a market-hater and I don’t particularly like bearish market conditions. It makes trading gains exceptionally tough to come by, or at best extremely short-lived. That said, letting the air out of what appears to be unrealistically high equity prices creates more solid trading opportunities down the road when market conditions regain their upward trajectory. In light of this, I want to discuss some stocks and sectors that might end up either saving you some losses, or allow you to trade for some nice bounce back gains.

Energy

Small-cap energy stocks have been among the hardest hit in recent dealings, thanks primarily to a precipitous drop in the price of crude, currently sitting at under $90 per barrel. Will oil prices remain under pressure short-term? Probably. Will they rise again? Almost invariably.

I’ve discussed several stocks in this sector this year, with Enservco (ENSV) and Profire Energy (PFIE) two of my favorites. Both issues have pulled back sharply during the market downturn, but I believe both will offer value when sentiment reverses to the upside. Profire is already a profitable concern that issued a solid outlook going forward in its last earnings report — something that bad equity market conditions shouldn’t affect.

The stock also has about 17% of its shares sold short, which should create the conditions for a nice covering rally at some point. Shares have plunged from almost $5.50 to $3.50 in a matter of weeks. Keep this one on your radar for a turnaround.

Enservco (ENSV) is another issue that has been hit hard recently, after challenging its $4 per share 52-week top. This is another company that appears to be in the catbird seat given its relationship to the growing “fracking” industry. Its share price hasn’t been hit quite as hard as Profire’s, and the company’s stock bears watching at its current level of about $3.45 per share. For both issues, earnings may provide a nice catalyst for some share price appreciation.

Ebola

Traders have been bidding up “Ebola” stocks as the virus has arrived in the United States, creating a growing fear that the disease will spread. As a result, the shares of companies like Alpha Pro Tec (APT) and Lakeland Enterprises (LAKE), which make and sell protective clothing and other accessories for health-care workers and first responders, have skyrocketed in price.

Long before Ebola, I had highlighted the shares of APT as a solid play on a company that was gradually growing its top and bottom line. I still like the stock, but so much fast money has moved into the issue that it seems like only a matter of time before it retraces some of its gains to the downside — especially when market conditions are frowning on these types of momentum moves. Even on big volume days, sellers have been more than happy to let their shares go at the $3.50 – $3.60 level, making me think that the primary move in this issue is over, and a more significant pullback will occur as fast-money players cut their losses.

The same is true for the LAKE, which has seen its shares bid up by about 33%, topping out around $10.70 each earlier this week before pulling back to under $10 in recent dealings. Under current conditions both APT and LAKE remain the riskiest of plays, but could regain traction if the Ebola threat continues to grow. Fundamentally, though, they both appear to be overvalued at these momentum-inflated prices. Which brings me to my third and final topic today…

Apple Pay and Momentum Movers

One thing I’ve noticed through the years is that when trading conditions are extremely favorable, as they have been for the most part over the past two years, “momentum” stocks — usually characterized by small floats and good headline-grabbing stories — can rise to unexpected heights. And, under bullish conditions, those issues often hold and build on those gains over several sessions, or even for weeks at a time. Unfortunately, when bearish conditions take hold, shares of those issues are often the ones investors jettison as quickly as possible.

In the wake of the news that Apple was going to market a all-in-one virtual payment solution, the share price of several small-cap stocks with related businesses went ballistic. Two in particular Net Element (NETE) and NXT ID (NXTD) experienced parabolic moves, and both have managed to hold on to some of those gains even during the current market-wide spate of selling. Even so, if you’re waiting for these stocks to resume their ascent, you may be waiting a long time. Neither have fundamentals that appear to support their current prices, and when the momentum crowd finally abandons issues like these their share prices can fall in a hurry. Avoid these plays for now!

Final Thoughts

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Transitioning from favorable to unfavorable market conditions is one of the most difficult things a trader has to adjust to. In that context, the price of a stock like PFIE that may appear to be a bargain at $5 per share may be anything but at $3.50 per share as long as the market remains in corrective mode.

Also keep in mind that a true, technical correction — which most market pundits view as a 10% drop — would take the Dow well below the 16,000 level. In my view the U.S. economy remains too strong for that to happen, barring any additional catastrophic global events, but we may have entered a time of lower-price consolidation for both the markets and most individual equities.

The good news is that at some point a powerful reversal to the upside should once again lift all boats — so make sure to compose a nice watch list of your favorite plays to take advantage of that move when it comes!
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As always, trade with caution — especially in these bearish times!

Warren Gates, Senior Analyst, Normandy Research

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