2015 finished much the way it started: With crude oil on the slide, the Dow Jones Industrial Average near 18,000 and the focus on the specter of interest rate hike from the Federal Reserve.
In the end, the Dow Jones lost 1% to finish the year off 3.5%, the S&P 500 lost 0.9% to fall to 2.2% in 2015, the Russell 2000 lost 1.2% to drop to 6.5% year-to-date, and the Nasdaq Composite lost 1.2% but still managed to gain 4.2% on the year.
It was a disappointing performance for the bulls. Consider that Apple Inc. (NASDAQ:AAPL), the most popular and widely held single stock based on its market capitalization, posted its worst single-year performance since 2008.
Both investment-grade and high-yield corporate bonds are down for the year.
Crude oil has lost more than $10 a barrel.
So what will 2016 bring?
On a technical basis, stocks are looking vulnerable heading into the new year. The S&P 500 has dropped back below its 200-day moving average and is constrained by an epic rounded top pattern that started in late 2014. This is the kind of pattern typically seen at the terminus of long-term bull markets, a slow grinding pattern of higher highs and higher lows giving way to a pattern of lower highs and lower lows over many months.
Unless the bulls can break up and out of the pattern, invalidating it with a surge back over the 2,100 level on the S&P 500, the bears are running the show.
Adding to the worries has been a steady narrowing of measures of market breadth or the percentage of stocks in the market participating to the upside — a sign of narrowing buying interest suggesting lower prices are coming.
Another way to look at the vulnerability of the overall stock market has been the reliance on a small group of big-tech stocks — including Netflix, Inc. (NASDAQ:NFLX) and Facebook Inc (NASDAQ:FB) — to keep the major averages held aloft while more and more less popular issues roll over.
It doesn’t help that the economy is cooling. Manufacturing activity is slowing sharply, with industrial production dropping 0.6% in November for the weakest result since 2012. Home sales are slowing. The list goes on.
As a result, the Atlanta Fed’s real-time GDPNow tracking estimate of Q4 GDP growth has collapsed to just 1.3%.
It doesn’t help that Fed policymakers are pricing in another four quarter-point interest rate hikes in 2016 (well below the pace of the last few tightening cycles) while the futures market expects just half of that pace.
And it doesn’t help that crude oil prices are likely headed even lower in the new year thanks to a growing oversupply problem and rising risk of “tank tops” as inventories swell. While U.S. shale oil producers have been idling drilling rigs, overall production remains just off of its high as more productive, lower-cost wells are ramped up.
Moreover, OPEC is continuing its price war strategy against U.S. shale. And the market is shuddering at the thought of Iranian crude hitting the market as economic sanctions are lifted. Goldman Sachs warned clients that a drop to the $20-a-barrel level could be necessary to force the production cuts necessary to balance supply and demand. Everything from energy stocks to high-yield bonds of shale producers will depend on whether or not this scenario actually plays out.
Because of the drag from a stronger dollar (which hits foreign earnings) and weak oil prices (which hits energy sector profits), FactSet data shows that overall S&P 500 earnings growth is expected to drop in Q4 for the third consecutive quarter — something that hasn’t happened since the financial crisis.
Specifically, earnings are expected to decline 4.7% in the quarter over the same period in 2014. This is a big markdown from the 0.6% drop expected at the end of September. Energy and material earnings are the big drag here.
Analysts are pretty dour on the outlook for the energy sector looking ahead to 2016 as well, with aggregate earnings estimates down 15% since September for a year-over-year earnings decline of 8% now expected for the calendar year.
Because of all this, I continue to recommend a defensive positioning to clients, including recommendations such as the AAPL Jan $110 puts, which are already up more than 90% for Edge Pro subscribers since recommended on Dec. 17.
Anthony Mirhaydari is founder of the Edge and Edge Pro investment advisory newsletters. Free two- and four-week trial offers have been extended to InvestorPlace readers.
