MorningWord 1/5/16: A Vicious and Inauspicious Start

by Dan January 5, 2016 9:48 am • Commentary

All things considered, yesterday’s 1.5% loss in the S&P 500 (SPX) wasn’t all that bad relative to the rout in global equities. Add to that the fact that investors in U.S. high growth / high valuation stocks that massively outperformed in 2015 were just waiting for the first opportunity in the New Year to book some profits.  Yeah, China’s equity volatility seeped into Europe and was the catalyst for a broad sell off here in the U.S., but its my view that we would have likely been down without it.

If the early year selling were to ignite into a meaningful correction in the coming weeks it would need some sort of further spark. That could merely be the snowballing of a global growth scare that was yesterday’s culprit. And that would not be too dissimilar to the January/February periods in 2014 and 2015. But they only saw 5% sell offs from the Jan highs to Feb lows. Given the overall stall in the SPX in 2015, I suspect this time around the correction would be deeper and likely more prolonged than a matter of weeks.

The other catalyst for a sustained pullback could be Q4 earnings. We will start to see them reported in the next couple weeks and expectations are for another decline. FactSet says if we were to get the 4.7% estimated earnings decline, it would mark “the first time the index has seen three consecutive quarters of year over year declines in earnings since Q1 2009 through Q3 2009”.  What’s clear is that the U.S. is in a corporate earnings correction, with industries like energy and related industrials in a full-on recession.  And what has been helping may not longer be counted on. Companies like Apple (AAPL), with a heavy weight in the SPX, has been a massive contributor to earnings growth. But last fiscal year AAPL grew at north of 40%. This year it’s only expected to be 5%.

If energy does not rebound, and industries like technology and consumer discretionary were to start to wane in 2016, we would see our economy contract. And that’s at a time when upward momentum in U.S. equity markets has narrowed to a few dozen growth stocks, albeit ones that have been able to execute their businesses in a less than optimal growth environment.

Looking at the SPX:

Since the August swoon in global equities, it has been my steadfast view that the highs were in for the year, and that 2100 in the SPX will remain staunch technical resistance.  The downtrend channel since the early November highs confirms this, with a series of lower highs and lower lows, with the SPX yesterday making a new (brief) intra-day 3 month low:

SPX 1yr chart from Bloomberg
SPX 1yr chart from Bloomberg

To say that the SPX is at a precarious spot in an understatement.  But the SPX stopped where it was supposed to yesterday and was off the lows into the bell. That could set up for a move back towards 2050, but you know what I’d want to do there.

The Flip-Side:

And it’s not like there aren’t near term positive catalysts that could calm equity markets. That’s one reason why we don’t press shorts on days like yesterday. First and foremost, surprisingly strong Q4 earnings and forward guidance from U.S. companies would do the trick. But that seems optimistic given the strength of the dollar weighing on large multi-nationals profits, weak manufacturing data just reported and what will likely be an uptick in jobless claims entering into a seasonally weak period.

Additionally, investors may start to anticipate dovish commentary from the Fed at their next FOMC meeting on Jan 27th. It’s my view that cautious commentary regarding global growth and any reluctance to hike rates too far too fast will be bearish for stocks. That’s because there’s a growing sense that the Fed has exhausted its bag of tricks and if we did see global recession there’d be little they could do about it. As laid about by John Hilsenrath of the WSJ on August 17th, 2015:



Obviously the PBOC can do its thing, throwing good money after bad to quell stock market volatility, as they did overnight. But they have taken extraordinary measures since the Shanghai Composite topped out in June, and the index is still down 37% from those highs, and its weakening currency is causing serious volatility in other global risk assets and likely remains a bigger concern than their stock market.

The ECB has shown its hand. With its wishy-washy commitment to further QE in early Dec that sparked a huge rally in the Euro/USD cross from 1.05 to 1.10. But after initial gains yesterday, the Euro is now down close to 2%.

Central bank polices are diverging, at a time where there are more questions than answers regarding the health of the global economy. And the available tools to spur growth and halt deflation feel a bit more like pushing on a string than accomplishing their desired effect.

In sum, I am a seller of U.S. stocks between 2050 and 2100, as has been the case since August, and I will reiterate my view that the path of least resistance is no longer higher for U.S. stocks. And quite frankly, the bull market, that started in March of 2009, seems like it’s over. And it likely has been for months.