Stocks got off to a terrible start in its first week of 2016 – the worst start to a year ever, according to Barron’s. The S&P 500 closed the week down 6%. Most major averages posted similar declines. The S&P 400 Mid-Cap Index fell 6.4%. The S&P 600 Small Cap Index fell 7.2%.
All S&P 500 major industry sectors declined. The biggest losses were borne by the most cyclically sensitive sectors – Materials, Financials, Technology, Energy and Industrials. Utilities was the best performing sector, down only 0.4%.
In the subsectors, Gold Miners led the pack with a gain of 0.7%, the only subsector to post a gain. Nonferrous Metals was the worst-performing subsector, plunging a whopping 20%. (Freeport McMoRan (FCX) dominates this two stock Dow Jones subsector.)
The selling was sparked by a 7% plunge in the Chinese stock market on Monday. The plunge occurred during the first 30 minutes of trading, forcing a shutdown for the balance of the day. Investors were concerned about skidding industrial production and another decline in the yuan.
China is important because of its linkages to other (emerging market) countries. The plunge in China’s stock market raises fears about a global economic slowdown. The greater declines in “risk-on” or cyclically sensitive S&P 500 major industry sectors echoes this fear. Despite Friday’s stronger-than-expected December jobs report, the financial markets are increasingly concerned that weakness in global commodity prices and U.S. exports (as a result of the strong U.S. dollar), will lead to further slowing in the U.S. economy.
This sentiment can also be seen in the recent trends in homebuilder stocks. My homebuilder stock price index, which had been outperforming the broader market handily until last April, has slipped steadily since. Last week, it plunged 13.1%, erasing all of the gains that it had recorded since the summer of 2012. With that plunge, the group is now trading at 11.7 times estimated 2015 earnings and only 9.0 times projected 2016 earnings. Analyst estimates still anticipate average 2016 EPS growth of about 35% for the group; but the market apparently thinks that it ain’t gonna happen.
Housing is driven in large part by job growth and mortgage rates. Job growth has been strong and mortgage rates remain low at about 4%. Despite the prospect for rising rates in 2016, any increases mortgage rates will likely be modest (based upon the “consensus” forecast for the economy) and should not derail the housing market. The stock market, therefore, appears to be ignoring these favorable factors, apparently in fear that the growing weakness in industrial production will spread to other parts of the economy, including those that are consumer-driven.
Throughout the past year, I have held out hope that the stock market could resume its upward climb. This was based upon the prospects for a QE-driven pickup in economic growth in the Eurozone, which would help lift interest rates and the euro. That, in turn, would ease pressure on the economies of the U.S. and China, both big exporters to the EU, and also provide a shot-in-the-arm to emerging market economies.
That optimistic view was bolstered in late August and early September of last year, when the U.S. stock market recovered from its earlier China-driven plunge. A successful retest of the lows in late September sparked a 13% rise in the S&P 500 in October; but the market has been struggling to hold on to those gains ever since.
With the most recent decline (in six of the past seven trading sessions), the S&P has broken through previous support around the 2000 level and is now well on its way to making a second retest of the August 24 intraday low of 1867.01. If the Index breaks through that level, the S&P could fall more precipitously – conceivably as low as 1400, based upon a Fibonacci retracement of the bull market’s gains since the March 2009 lows.
I still prefer to look at the glass half-full, but it is admittedly getting harder to do so. This market has become increasingly narrow, with gains from FANG (i.e. Facebook, Apple, Netflix and Google) holding up the major averages. Most stocks have been suffering through corrections, but this could also position the market for a rebound.
Still, the longer the market fails to rally and the more it retests previous lows, the harder it is to maintain an optimistic outlook. Since November, the S&P has developed a clear pattern of lower lows and lower highs, which defines a downtrend. If the market is unable to hold above the August low, downside selling volume will probably increase.
So how should the average investor respond? Like Barron’s Streetwise columnist Ben Levisohn, I think that it makes sense to “buckle up, but don’t bail out.” But how does one buckle up? The most effective way is first to make sure that one’s financial situation is in order (recognizing that all investments in public market securities are “at risk”). Besides that, increasing exposure to less cyclical stock sectors is an obvious way. Investing in asset classes or individual stocks that should hold up, even if the world as we know it comes to an end, is another. Maintaining exposure to certain sectors, such as energy, that have been decimated over the past year, may be an effective hedge under certain downside scenarios. By “buckling up,” the average investor should still be able to participate on the upside, if the market does find its legs, but also avoid some losses, if it doesn’t.
January 10, 2016
Stephen P. Percoco
Lark Research, Inc.
P.O. Box 1543
Linden, New Jersey 07036