Worst Start Ever

Well, there is no need to mince words about how the year for stocks is starting out. The first week of trading in 2016 has turned out to be the worst start to a year for stocks in history! 2015 ended the year as the worst year for stocks since 2008. U.S. stocks closed out the final trading day of 2015 with both the Dow and S&P 500 suffering their first year of negative returns since 2008 when the financial crisis was in full swing.

The S&P 500 had a loss of less than 1% and the Dow Jones Index finished 2015 with a loss of 2.2%. As of this writing the S&P 500 is down 7% and the Nasdaq is down 9% since the start of 2016.

The reasons for the declines are many: The end of Quantative Easing by the Fed; the first official interest rate increase in years; and extremely over inflated assets around the world funded by cheap debt.

Because of the amount of debt created in the last eight years, central bankers remain desperate and are taking all measures necessary to stimulate growth and inflation. That’s the only way to pay down the debt in the future.

Earnings growth in jeopardy
Investors in the S&P 500 have had to endure something in 2015 that they haven’t seen since 2009: persistent weakness in corporate profits. During the second and third quarters of 2015, the S&P 500 posted year-over-year declines in earnings, and as of the end of the year, analysts expect another round of falling earnings when companies report their fourth-quarter results in the next few weeks. Analysts expect earnings to fall by about 4% when S&P 500 companies report their fourth-quarter earnings starting this week and for revenues to decline about 3%. If things work out that way, the S&P 500 earnings will fall in 2015 for the first time in six years. Forbes reports, “This follows a drop of 0.8% in the third quarter. If the market does have two consecutive quarters of negative earnings growth, it would meet the definition for a profit recession. This is clearly the biggest risk markets are facing right now, as a contraction in earnings could presage an economic recession.”

Commodities in a spiral
Around the globe, commodity prices are in a full-scale depression. We all know where a barrel of West Texas oil is trading. Unprecedented demand to meet China’s construction demands over the last twenty years is slowing dramatically. The New York Times reported, “China’s economy is slumping. U.S. companies, struggling to pay their debts as interest rates rise, must keep producing. All the excess is crushing prices; hurting commodity-dependent economies across emerging markets like Brazil and Venezuela and developed countries like Australia and Canada. The geopolitical and financial consequences of this shift have shaken investor confidence. Concerns over global growth intensified in recent days, when weakness in China prompted a stock sell-off.”

It’s amazing to see the cause and effects of the trillions of dollars of cheap debt that has been issued in the last few years to finance commodity-based assets and fund public entitlements.

Where we are today:

One-Year chart of the SP500. The red area is the trading range year to date.

chart

As you can see, the SP500 is very oversold on a short-term basis accompanied by an extraordinary level of volatility. We are very close to approaching last year’s lows: the 1000-point decline on August 24th.

Despite formidable headwinds, lower prices will bring great opportunities to buy great companies.

We are due for a rally!

J. Brock Hamilton
January 13, 2016