Investors are bracing for more volatility in 2016 after the stock markets ended slightly in the red in 2015. The S&P 500 ended the year down around 0.7%. The markets saw a substantial decline in August and September after uncertainty in China's stock market spooked investors. Oil and gas prices continued to remain low, which hurt the energy sector. The multiyear rally in health care and biotech stocks also hit a snag. Still, investors are looking for potential opportunities in 2016.
Consolidation in the Energy Sector
There will be significant consolidation and buyouts among companies in the energy sector. Despite some experts predicting a recovery in oil prices in 2015, oil actually fell further. Starting the year around $55, crude oil ended the year at about $37 a barrel. The low prices will force smaller companies to sell out to larger companies. While it is unclear whether oil prices will recover in 2016, a continuing supply glut combined with reduced demand make it appear that any substantial rallies in price will be tough to sustain.
Low prices are starting to eat into revenues for all companies in the sector. However, the smaller oil and gas companies are really starting to feel the heat. These companies issue a significant amount of debt to finance their operations and expansion. This debt often carries a lower credit rating for the smaller energy companies. There was a significant sell-off in high-yield debt in the latter part of 2015. Smaller energy companies will have difficulty financing their operations further in 2016 as oil prices remain low. They will be forced to sell assets to larger oil companies.
The larger energy companies can weather the storm by cutting costs and scaling back on capital expenditures. Some of these companies will have sufficient cash to buy attractive assets from smaller players at cut-rate prices. There is a likelihood that larger companies will buy out smaller companies that are not generating enough cash flow to stay in business. The larger companies have the ability to plan and invest on longer time frames.
Stock Market to Remain Flat
The stock markets will have another fairly flat year in 2016, albeit with significant market volatility. The same issues with the Greek debt crisis and a slowing economy in China will arise at some point during the year. Analysts from Goldman Sachs have stated that the S&P 500 will end 2016 at around 2100 after ending 2015 at around 2035. It is fairly uncommon for the markets to remain flat in consecutive years, but there are economic factors that serve as headwinds to further growth in 2016.
The dollar remains strong, which hurts the cost of exports to other countries. It further reduces demand for commodities from the United States. Companies that do business overseas will continue to see an impact on revenues from the higher dollar. This will continue to be a drag on the economy.
The Federal Reserve will also continue to raise interest rates, which will increase market volatility. The markets enjoyed a free flow of easy money in the wake of the 2008 financial crisis, which supported the bull rally over the past few years. As interest rates increase, companies will be less likely to engage in share buybacks and dividend increases. Companies will not have access to this cheap capital any longer. Buybacks, in particular, supported share prices for many companies. Without these buybacks, companies will be forced to look to organic growth to increase revenues.
Pullback in Biotech Sector
The new year will also see a pullback in the biotech sector as a multiyear bull run in the sector comes to an end. Company valuations in the sector remain high. Further, drug companies are facing increased scrutiny for high drug prices. Incidents in the sector in 2015 cast a negative light on a few drug companies. This has led to Congress taking a much closer look at drug prices, which will definitely impact the sector.
There are certainly strong performing biotech companies with exciting products in their pipelines. These companies will continue to perform well. However, companies with suspect pricing practices or subpar products will face pressure in the new year. There will also continue to be significant merger and acquisition (M&A) activity in the sector, but perhaps not to the extent seen in 2015.
