After the worst January for stocks ever, investors are being battered again on Monday as a brief reprieve fueled by hopes of fresh cheap money stimulus and negative interest rates fades. The catalyst: the reappearance of the eurozone debt crisis adding to an already long list of worries.
In the end, the Dow Jones Industrial Average lost 1.1%, the S&P 500 lost 1.4%, the Nasdaq Composite lost 1.8% and the Russell 2000 lost 1.7%. On the flip side, Treasury bonds strengthened, and gold surged 3.5% for the best one-day gain since December 2014.
The Russell 2000 pushed below its recent low to return to levels not seen since the summer of 2013 for a total loss of more than 26% from the June 2015 peak through the day’s lows. Large-cap stocks aren’t far behind (down nearly 19%) as the entire market completes what looks like an epic, 3-year-long topping pattern.
This doesn’t look like a typical bull market pullback. It has all the hallmarks of something much worse.
There are a few factors in play.
- Some political risk is popping back up (Spain basically has no government right now, and Greece is having bailout issues again)
- That’s hitting banks because of possible asset value impairment.
- Banks are being hit by worries that Deutsche Bank AG (USA) (NYSE:DB) doesn’t have enough capital to meet new regulatory requirements.
The stress is manifesting in more obscure areas of the European debt market, with the value of Deutsche Bank contingent collateral or “CoCo” bonds plummeting (on fears of conversion into equity) while the value of its credit-default swaps (a measure of fear) soar to levels last seen in 2011.
The kicker is that the recent move by the European Central Bank and the Bank of Japan to push policy rates into negative territory weakens banks by pushing net interest margins — the gap between loan and deposit rates — even lower.
Investors are kind of freaking out about this, because it risks undermining the thesis that more monetary policy stimulus is always and everywhere a good thing. More negative rates now would only further weaken the banks. More asset purchases would further reduce the supply of high-quality collateral banks need for inter-bank lending.
But clearly, policymakers are likely to respond in some new creative form (money dropped from helicopters?) and that’s why precious metals and the related mining stocks are going absolutely crazy. That and the rising specter of trouble in the credit markets.
Europe adds yet another wrinkle to the list of concerns for 2016: a strong dollar, weak oil prices, U.S. economic stalling, China’s problems, geopolitical risks and falling corporate profitability.
A downward spiral is developing. Reports are crossing that shale energy icon Chesapeake Energy Corporation (NYSE:CHK) has hired bankruptcy lawyers. Fears of shale energy bond defaults have pushed the SPDR Barclays Capital High Yield Bond ETF (NYSEARCA:JNK) to levels first reached in 2012, while the Financial SPDR (NYSEARCA:XLF) is at risk of losing its 200-week moving average for the first time since 2012.
Safe havens are few and far between. Treasury bonds are rallying, but carry a negative real interest rate. Gold looks better as it looks ready to emerge from its post-2011 downtrend. And precious metals stocks look best, at least for investors with the ability to tolerate the risk, since valuations have been bombed out.
Edge subscribers are enjoying a 27% month-to-date gain on a handful of gold and silver stocks including a 46% gain in Kinross Gold Corporation (USA) (NYSE:KGC) and a 28% gain in Goldcorp Inc. (USA) (NYSE:GG). Edge Pro subscribers are carrying a 425% gain in their Feb $105 SPDR Gold Trust (ETF) (NYSEARCA:GLD) calls.
Further gains for gold and silver look likely this week as Federal Reserve chairman Janet Yellen gives her semi-annual monetary policy testimony to Congress starting on Wednesday. She is expected to talk up the rising risks to their inflation outlook (which remains below their 2% target) as a result of market volatility tightening financial conditions.
This should further push back expectations of a rate hike until the second half of 2016 or early 2017. But until the economic data revs back up, oil prices stabilize and bond markets calm down, stocks are probably going to keep drifting lower.