The stock market has performed a spectacular bungee jump in the opening days of 2016. (As of Friday’s close, the S&P 500 Index had dropped 8.0% since December 31, easily the worst January start since 1928, when daily S&P record keeping began.)
The big question now: Can the cord hold?
We did get some fairly encouraging news late last week, with the S&P 500 probing new lows for the month in the first half-hour of trading Thursday, and then reversing strongly to the upside. The index closed with a robust gain of 31 points, or 1.7%.
However, a one-day bounce doesn’t prove that the bungee cord is really made of the right stuff. For convincing evidence, the headline equity indexes must follow through quickly with a series of powerful one-day advances. The size of the bounce will speak volumes about whether the 2009-15 bull still has further to run—or whether the bear has taken over for an indefinite period.
In addition, as I’ve emphasized on numerous occasions lately, we must observe some clear-cut improvement in the credit markets.
On that score, Thursday’s action only rates a “meh.”
Take a peek at this chart, which compared the day’s price performance of the S&P 500 index and that of the largest junk-bond ETF, iShares iBoxx High Yield Corporate Bond (HYG). As you can see, both the S&P and HYG bounced together off their early-session lows.
However, the S&P continued to roar ahead for the rest of the day, while HYG settled for a much more modest 0.45% gain on the session—barely above the fund’s morning high.
In other words, we’re noting (so far) little evidence of a break in the severe tension that has built up in the credit markets. As a contributor to the problem, the Fed’s recent quarter-point rate hike is trivial; what matters is the steep 300-basis-point increase in borrowing costs that less-creditworthy businesses (junk-bond issuers) have endured since February 2015.
A “stealth” credit tightening of that magnitude hurts. It harbors the potential to crimp business capital spending and to squelch the mergers-and-acquisitions boom. Unless this trend begins to reverse decisively within the next week or two, it will spell more trouble for the stock market as the year unfolds.
As far as investment strategy goes, I continue to recommend an extraordinary degree of caution. Make sure you’ve got an adequate cash reserve on hand to see you through any further rough spots in the markets.
How much cash is enough?
Hold enough cash to let you sleep well. As an old Wall Street adage says, “Sell down to the sleeping point.”
Once you’ve reached the sleeping point, you can nibble selectively at these two stocks and mutual funds. At the moment, I’m particularly keen on Vanguard High Dividend Yield Index Fund (VHDYX) and its exchange-traded clone, Vanguard High Dividend Yield ETF (VYM).
Both funds are throwing off a yield of well over 3%, based on the past four quarters’ distributions. If Wall Street continues to give us a rough ride this year, you’ll be glad to have a steady stream of dividends coming in to soothe your nerves.
Better yet, these funds are now trading at about a 10% discount to their 2015 highs. That means you’re already well ahead of the headstrong investors who insisted on paying top dollar back in May. The lower the price you pay, the bigger your prospective profits.
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