Brace for Turbulence

On May 19, 2015 the Dow Jones Industrials finished the day at 18,312 – a record close.

On August 25th, the index closed at 15,666, down 2,646 points or 14.5% from its May high. The day before, the Dow Jones Industrials went down over 1000 points in the opening minutes of trading. Dow and S&P 500 components such as G.E., Apple, Merck and Home Depot had traded 15-25% lower than where they were trading the previous week. Many other stocks and ETFs were down more than 50% alone during the first several minutes of trading on August 24th. Officials remain clueless as to the reasons for the price volatility that day.

As for September 30th, the third quarter included the largest percentage declines for U.S. stock indexes and the most volatility since 2011.

The Dow closed down 7.5 % for the quarter and 8.6 % year to date.

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The Dow Jones Index has been swinging up and down an average of 350 to 400 points daily since mid August. The reasons are many. Growth in China is slowing, U.S. corporate earnings estimates are declining and, as usual, the Federal Reserve’s complete lack of credibility and dysfunctionality has investors paring back equity exposure.

Speaking of the Fed, the greatest monetary experiment in the history of the world continues. Bloomberg reports, “The bond market isn’t buying what Federal Reserve Chair Janet Yellen is selling on inflation. While she reiterated last week that the Fed expects inflation to gradually rise back near 2 percent, long- and short-term market forecasts for price gains have plunged to their lowest levels since 2009.” How could anyone forget 2009?

Earnings are the most important driver of stock prices. Recently, earnings growth has flattened out and expectations for coming periods are for negative growth.

The WSJ reports “two factors are giving some analysts and traders pause and likely leading to further market swings: Wall Street analysts expect quarterly corporate earnings will decline for the second quarter in a row for the first time since the financial crisis, and financing conditions are tightening in corporate-bond markets”.

“3Q earnings season could prove turbulent given recent macro developments,” Goldman Sachs’ David Kostin wrote on September 25th. “Slower economic growth in the US and China and a lower oil price than we previously assumed translate into a reduced profit forecast and a lower trajectory for US stocks.”

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On the energy front: Can you imagine what the price of oil would be without the new U.S. fracking technology now that the Russians are the leading superpower in the Middle East? How about north of $200 a barrel!

Crude oil remains low at $45 per barrel but we are starting to hear reports of production declines (which is positive) and banks reducing credit lines for many U.S. energy companies.

The Baker Hughes rig count came out today. The number of active oil and gas drilling rigs in the United States is now 809 – a decline of 1113 or 58% from this day last year. This news, along with the low price of oil, declining production and banks reducing credit is all very positive for future investment in energy stocks. These factors should eventually lead to higher prices.

With the earnings outlook souring, markets down for the year and the Fed in disarray, what can one conclude? I’ll take a long shot and guess that the 4th quarter will actually turn out to be a pretty good one. Who knows, I’ve heard the words Melt Up being thrown around. We shall see.

J. Brock Hamilton
October 2, 2015