Stocks are under incredible pressure on Friday, with the Dow down more than 500 points at its low while large-caps lost August 2015 “flash crash” lows to return to 2014 levels. Things are even worse for small-cap stocks, with the Russell 2000 falling below the 1,000 level to return to July 2013 levels.
In the end, the Dow Jones Industrial Average lost 2.4% to close below the 16,000 level, the S&P 500 lost 2.2% the Nasdaq Composite lost 2.7% and the Russell 2000 lost 1.8%.
The catalysts are familiar to anyone reading my work: The current rout in crude oil, domestic and international economic weakness, lackluster earnings, the looming threat of additional Federal Reserve rate hikes and bond market vulnerabilities.
Energy stocks have been bombed out. Financial stocks are being pushed to three-year lows on net interest margin pressure, fears over energy loan losses and reduced trading revenue. And popular Big Tech momentum stocks like Apple (AAPL) are being caught in the whirlwind too — which helped Edge Pro subscribers nab a 380% gain in their Jan $110 puts.
Treasury bonds were stronger, the dollar was weaker, gold gained 1.4% and crude oil lost 5.7% to close below the $30-a-barrel level for the first time since 2003. Rising fears of defaults by U.S. shale oil producers pushed the Barclays High Yield Bond SPDR (JNK) to levels not seen since 2012.
Overseas, the Shanghai Composite lost 3.6%, Germany’s DAX lost more than 2.5% and Japan’s Nikkei lost 0.5% to close at 17,147 — down nearly 15% from its early December high and down.
Whether the losses deepen, or an oversold rebound materializes, depends on whether Fed policymakers can restore hope. They can do this by backing away from their four-in-2016 rate hike forecast.
But if they stick to their guns based on labor market gains, they’ll leave financial markets adrift without the cheap money support they’ve counted on for years.
The economic data certainly supports a dovish turn by the Fed. Headline retail sales dropped 0.1% in December to gap a mere 2.1% gain for the year in the weakest performance by consumers since 2009.
Industrial production fell a larger-than-expected 0.4% in December over November, pulling down the capacity utilization rate to 76.5% which is bad for profit margins. U.S. freight volumes are falling for the first time in three years. Walmart (WMT) is firing 16,000 workers and closing 269 stores globally.
After the close, the Atlanta Fed’s GDPNow estimate for Q4 GDP growth dropped to just 0.6%.
Long story short: A deflation dynamic — led by weak oil prices — is ripping through an over indebted, over leveraged and overly optimistic financial system. It’s fueled by a mix of Fed policy tightening (QE3 bond buying ended in December 2014 and rates were hiked 0.25% in December 2015 for the first time since 2006) and a U.S.-OPEC oil price war.
Other wrinkles include the situation in China (currency instability and capital outflows), weak corporate earnings (on track for a third-quarterly decline in Q4), and the fact that cheaper oil prices have done more to hurt (by cutting capital investment) than help (by boosting consumer spending).
The kicker: If the Fed can engineer a reversal of the cheap oil/strong dollar dynamic, by holding off on rate hikes or even considering new stimulus measures, that market could quickly rebound.
This would be at the risk of lost credibility by Federal Reserve Board Chairman Janet Yellen, the reinforcement of the idea of the “Fed put” and the encouragement of excessive risk taking by complacent investors, and the not insignificant risk of runaway inflation down the road.
We may have already seen a hint of this: Earlier today, New York Fed President William Dudley said negative interest rates would be considered if the economy weakened. As recently as September, now retired Minneapolis Fed President Narayana Kocherlakota was suggesting negative interest rates were appropriate in 2016.
In anticipation of this, I’ve sold the majority of my put option/long volatility positions over the last few days and added precious metals exposure including the ProShares Ultra Gold ETF (UGL), which is up 5.2% for Edge subscribers so far this month — helping cap a 9.7% month-to-date overall gain vs. the 7.9% loss for the S&P 500 thanks largely to a 27% trade gain in the iPath Short-term VIX (VXX) sold on Wednesday.
Anthony Mirhaydari is founder of the Edge and Edge Pro investment advisory newsletters. A two-week and four-week free trial offer has been extended to InvestorPlace readers.
