Coming into today, the S&P 500 (SPX) is down 75 basis points on the year, and down 1.8% in the month of December. This morning the futures are bid up 55 basis points, and no matter what happens following the FOMC meeting today, I suspect that the index closes up or down a couple percent from current levels. If the index closes down it will be the first annual decline since 2008, and only the second since 2002. In 2011 the SPX gained just one point, closing flat on the year, and there have been many comparisons made between 2011 and 2015, as both years had sharp August draw-downs that had a sort of a contagion feel to it, only to come roaring back in October and stabilize into year end.
Recently I have made the case that 2015 also has a sort of 2007 feel to it, another year of fairly tepid returns (SPX closed up 5.5%) but also had a swoon in August that in hindsight was a prequel to the financial crisis the following year.
Here is the chart of the three years, 2015 down 1.8%, 2011 flat, and 2007 up 5.5%, all have a similar sideways feel despite some mid year volatility:
The heat map of the monthly returns of the three years is kind of interesting. On average all three years saw declines in the last month of each quarter. Weak Junes foretold a nasty summer of volatility, followed by a rip in October:
What do you do with this? I could make some stuff up! But to be honest I’m not really sure. 2007 was followed by a 38% decline in 2008, and 2011 was followed by a 16% return in 2012, albeit from 800 points, or 40% lower than current levels in the SPX. Which leads me to believe that the current sideways action in large cap equities, the poor breadth and internals of most U.S. equity indices and the obvious stress in almost every risk asset class in the world as the Fed is about to raise interest rates for the first time since June 2006, means the path of least resistance for stocks is no longer higher and that an unwind or reversion of some crowded trades could lead to a sharp decline for U.S. stocks in Q1 of 2016. Its been our view that a slight re-positioning of equity exposure from high valuation growth stocks to domestically focused, defensive yield sectors like Utilities and Telecom makes sense here, at least on a relative basis.
I will add one more point. The extraordinary measures taken by the Fed and the Treasury in late 2008, that have essentially been in place to the current day have been one of the main reasons that the equity crash in 2008 was short and sweet. For those of you who don’t remember the last increase in the Fed Funds rate, then you certainly won’t remember the protracted bear market of 2000 thru the first quarter of 2003. You might have read about the dotcom crash that started in 2000, but you may not remember that in 2000 the SPX only closed down 9%, besting on a relative basis 2001 that closed down 12% and 2002 which closed down 22%. Let me tell you that was an absolutely excruciating period to be an active equity market participant and it has scarred me to this day 🙁
So I guess the real question you have to prepare yourself for in the coming quarters/years is whether the next correction is violent and short, or a death by a thousand cuts. For those who have become accustomed to buying any and all dips, remember that only works with V reversals. If in fact U.S. equities are the last shoe to drop in what has been a rolling risk asset implosion for nearly two years, will the powers that be have the ammo and the tools to manufacture a soft landing with interest rates near zero and questionable results from years of QE?
We should see the next step in the process beginning today.