Thanks to a sharp fade in the final weeks of the year, 2015 saw the worst year for the Dow Jones Industrial Average since the dark days of 2008. And judging by the quick 7% decline to start the year, many are fearing another Great Recession is upon us.
Of course, some perspective is in order.
While 2015 was a bad year per set, the 2.2% total decline for the Dow Jones is hardly a doomsday scenario. And given the roughly seven-year bull market run, investors have had more than enough chances since the financial crisis to make hay while the sun was shining on Wall Street.
So what’s the score in 2016? Should we be worried that the market is going to fall apart, or are there signs of hope that hint at stability around the corner?
It all depends on your perspective.
Here are seven reasons why the market could be doomed for further declines this year … as well as seven reasons that the worst may be behind us.
Reason the Market Is Doomed #1 – China
The big story of the past several months has been the meltdown in China, as crashing asset prices there and a slowdown in growth threatens the economy of both the nation itself and its neighbors. The nation saw its weakest GDP growth since 2009 last year, and many insiders continue to doubt that even those grim statistics from Beijing are accurate. In fact, a recent report hints that growth could have been as low as 2.4% — barely better than the major developed economies in the world. Any slowdown in China’s economy and Chinese demand will be felt across the world in 2016.
Reason the Market Is Doomed #2 – Investor Sentiment
For the first full week of the year, U.S. stock funds saw their worst week since September as investors pulled more than $12 billion out of this asset class. Every sector on the market is in the red since Jan. 1, and all 30 Dow Jones components have declined in value over the past 30 days. When investors think the fates are stacked against them, they remain reluctant to enter into the stock market and bid asset prices higher.
Reason the Market Is Doomed #3 – Oil
Crashing oil prices have resulted in big pain for energy companies. According to Talara Capital Management, at least one in five U.S. oil companies are at risk of restructuring, downsizing or all-out bankruptcy proceedings in 2016. Or if you want a more tangible figure, as of the end of 2015, some 250,000 jobs in the energy sector had been eliminated thanks to crashing oil prices. Seeing that oil prices have only moved lower over the last few weeks, that doesn’t bode well for the industry in 2016.
Reason the Market Is Doomed #4 – Corporate Profits
Although the economy at large is growing, there is much talk about an “earnings recession” as corporate profits are experiencing their third-straight quarterly decline. That’s the first time that’s happened since the early days of 2009. Specifically, financial research firm FactSet estimates a 5.3% decline on average for the component stocks that make up the S&P 500. While energy stocks are indeed a big share of the losers thanks to falling oil prices hurting margins, the overall picture is bleak across the board. Consider that of the S&P companies that have issued earnings guidance for the current reporting period, 83 have issued negative guidance vs. just 28 companies revising their profit estimates higher.
Reason the Market Is Doomed #5 – Rail Traffic
Railroads, the lifeblood of the U.S. economy, ship goods around the nation — and thus, are a proxy for overall economic activity and demand. Sadly, rail traffic has begun to fall off a cliff. Specifically, railroad cargo for 2015 dropped the most in six years — with carloads down 5% or more year-over-year each week for the past 11 weeks as of mid-January. It’s a recession-like reading from the index, which doesn’t bode well for either business or consumer demand this year.
Reason the Market Is Doomed #6 – Uncertainty over Interest Rates
At the end of last year, the Federal Reserve issued its first interest rate increase since 2006. But rather than provide stability to the market, the move has injected even more uncertainty as investors and consumers try to determine what the means in the long-term. Will the interest rate increases stick, and increase the cost of borrowing? Is the economy too weak to sustain the increase, and force the Fed to backpedal? When uncertainty over such a huge issue looms large, it’s difficult for assets of any kind to make headway.
Reason the Market Is Doomed #7 – Junk Bonds
Given the challenging environment, it’s not surprising that a number of corporations with distressed debt have found themselves unable to make good on their obligations. However, investors who had piled into junk bonds — that is, high-yield debt issued to sub-standard borrowers — have taken a beating that couldn’t come at a worse time. The rush for the exit has been so severe that the Third Avenue Focused Credit Fund blocked redemptions in December until it could find a way to unwind itself, and a fund operated by Lucidus Capital Partners was forced to liquidate its entire $900 million portfolio to satisfy redemption demands. When that kind of panic sets in, it has a chilling effect not just on the bond market but on other asset classes as well.
And now, onto the reasons why the market might be OK.
Reason the Market Is OK #1 – Jobs
No matter how you slice it, the rebound in the U.S. job market since the Great Recession has been nothing short of remarkable. The headline unemployment rate is holding strong at 5%, and the December jobs report showed an impressive 292,000 jobs created. There are indeed serious problems in the global economy, but the U.S. labor market is not one of them.
Reason the Market Is OK #2 – Housing
A big driver of the U.S. economy is the housing market, and most indicators continue to point upward for the industry. Consider that in the latest “Beige Book” report from the Federal Reserve, “residential construction activity was described as modest or moderate” in most areas. And from a price perspective, the latest S&P/Case-Shiller composite of home prices rose again month-over-month and posted a 5.2% annual increase. Continued strength in housing shows that this key industry is still going strong even amid other troubles.
Reason the Market Is OK #3 – Record Auto Sales
For all the talk about fretful consumers and millennials without driver’s licenses, 2015 was a banner year for auto sales. In fact, the number of vehicles sold last year was at the highest on record, topping the previous record set 15 years ago. Not only is that good for automakers and the employers of dealerships nationwide, but it’s also a good sign of consumer confidence as we enter 2016.
Reason the Market Is OK #4 – Oil Prices
Yes, we just talked about the pain that falling oil prices have caused for energy companies. However, crashing crude oil is a double-edged sword because significantly cheaper gasoline and lower heating bills act as a stimulus for consumer spending. The rough math on Wall Street is that every penny we see shaved off gas prices equals an extra $1 billion in discretionary income for American consumers … so given the record low fuel prices, that’s a whole lot more cash to go around right now.
Reason the Market Is OK #5 – Insulation From China
Another “good news, bad news” situation concerns China. Yes, headlines are grim … but problems in China do not necessarily result in problems for the U.S. economy. After all, America runs a roughly $340 billion annual trade deficit with China, so they are much more reliant on our economic fates than we are on theirs. In fact, Citigroup estimates that just 0.7% of overall GDP has direct China exposure. So let’s not worry too much about contagion from a China slowdown.
Reason the Market Is OK #6 – The Start to 2016 Is Just That … A Start
As the old adage goes, past performance is no guarantee of future returns. According to ETF.com, since 1926, there have been 33 years (roughly 37%) where the S&P 500 saw a loss across the first three months of the year. More than half, or 18 of them, saw the S&P 500 index back into the black and posting a profit by year’s end. Maybe a decline to start January isn’t ideal, but it certainly isn’t a death knell.
Reason the Market Is OK #7 – The Long-Term
It’s worth noting that there has literally never been a 20-year period in the past century or so that has resulted in a negative return for stocks. Or put another way, if you have a long-term horizon … it’s pretty much impossible to lose money. A recent example of this is the market crash of 2008-09 that erased more than 40% from major indices, and the subsequent bull market that got us back to new all-time highs by 2013. That may be cold comfort to those in the short-term, but if you are patient enough you will almost certainly come out ahead regardless of the crisis du jour.
