The Top 10 Reasons Why the Stock Market Will Tank in 2016
It’s the new year and everyone loves to make predictions. At Carden Capital, we recently came across an article showing S&P 500 target projections by the market strategists at fourteen top investment banks. All fourteen projected the market will go up in 2016 with an average increase of 6.5%. Not one of the market strategists predicted the market will go down. This is understandable. A falling stock market is bad for business and these banks depend and thrive on the bullish excitement and expectations of their clients. However, at Carden Capital we have adaptive strategies that can handle up and down markets, so we can tell it like it is, and in this case, we are highly confident that all fourteen top investment banks are going to be wrong.
We are confident that the market will be down in 2016 and enter into a corrective phase. With that introduction, we present to you the top 10 reasons the stock market will tank in 2016.
1. The stock market has gone up for the last 7 years in a row. Incorporating dividends into performance statistics, the market was up 1.4% this year, which means 2009 – 2015 were all up years. We analyzed historical market data going back to 1871 and found there was only one instance where the market went up for more years in a row, and that was 8 years in 1982 – 1989. In fact, the current seven year run stands alone. Most bull markets die out after four or five years. It would be rare indeed for this bull to charge forward any longer. We think this bull will turn bear in 2016.
2. Valuations are too high. If one looks at Professor Robert Shiller’s ten year cyclically adjusted price earnings ratio below, we have reached the level (25x earnings) where it generally stops increasing. This means, according to the Nobel Laureate, the only thing that can keep the market trajectory higher is earnings growth.
3. However, earnings are not growing. Global growth is slowing. China is slowing. In Q2 and Q3 S&P 500 earnings were down slightly year-over-year and Q4 is expected to be even worse. Some predict that 2016 will mark a return to earnings growth for the S&P 500. We don’t see it. Earnings are cyclical. After a prolonged period of earnings growth corresponding with a bull market, you end up at a point where there are peak margins, as is presently the case, and low or negative growth. That is when the market turns. Margins cannot stay high forever and earnings cannot keep growing.
4. M&A volume is at a record. M&A volume always peaks at the end of a bull market. Companies become overconfident because things have been going well for so long. Additionally, they have plenty of access to capital so they go on a spending spree right at the point when prices are at their highest. The last two record years were 1999 and 2007.
5. Stock buybacks are at a record level. The last time stock buybacks hit a record was in 2007. Just as with M&A, companies typically spend the most on purchasing their own equity at the wrong time when valuations are too high and economics do not justify the action. In 2015, the story has been companies taking advantage of low interest rates, issuing cheap debt in order to finance stock buybacks.
6. The S&P 500 buyback index has been underperforming the S&P 500 since Q3 2015. The buyback index measures the performance of 100 stocks with the highest buyback ratios in the S&P 500. It usually outperforms the index for obvious reasons – more buying than selling in those issues being bought back. Lately it has been underperforming. The last two times this happened were in 2000 and 2007 right at market peaks.
7. Stock market breadth is unusually shallow. The S&P 500 index is a market cap weighted index and in the last year strong performance within the ten largest companies, many of which are technology (think GOOG, AMZN, MSFT, FB), have masked broad losses across the market. The S&P 500 equally weighted index was down 4.11% in 2015. The implication here is that if the tech rally stalls, it will drag the market down in a big way. Or better said, on an equally weighted basis the market already knows the bullish trend of the last seven years is over.
8. Long term rates are not increasing. When the Fed finally pulled the trigger and raised short term rates in December, ten-year treasury bond rates did not move. The yield curve typically goes flat to inverted before a recession. History shows that the bond market is generally a bit smarter than the stock market. The yield curve is a great predictor. Watch this carefully in 2016.
9. Oil is at $37 per barrel. The Saudis just announced budget cuts and tax increases. They will not trim production until they have forced others out of the market, especially US shale, which cannot compete at these low prices. Therefore, we think the story of weak oil will continue and eventually lead to quite a few bankruptcies in 2016. We think this will shake the stock market. Moreover, the current divergence between the XLE and the price of petroleum tells us that equity prices of oil related companies are taking a wait and see approach in terms of the oil price. In March and August of last year, new lows in oil gave way to ferocious rebounds. Oil rallied from $42 to over $60 over a nine-week period beginning in March while in August it recovered from $37.75 to over $50 per barrel in even a shorter period. If a rebound in the price of oil does not come soon, the price of oil related stocks will have to correct and that correction is likely to be ugly.
10. High Yield is imploding. On December 10th, three high yield funds announced they were closing. The high yield market has been in a bubble for a long time due to ultra low interest rates. Again, the bond market sends signals ahead of time to the stock market. The recent weakness in high yield has been related to oil and energy, which accounts for about 15% of the junk bond market. Any time there is excessive leverage in the system, contagion risks increase. We think low oil prices will hammer high yield resulting in a lower stock market. To us, this feels eerily similar to July 2007 when the first MBS funds started to blow up. Most market professionals believed the damage would stay contained within the sub-prime market. The stock market shrugged it off, just like it shrugged off three high yields funds blowing up on December 10th, 2015. Where there is smoke there is fire. We see an inferno brewing.
It is going to be an exciting year filled with volatility. Next week we will introduce our free Smart Hedge™ market timing tool for investors and traders to follow that will allow market participants to avoid major market declines. Investors can receive the offering free by subscribing to the signal. It should be a very timely offering and well worth following. Stay tuned.
We wish everyone a prosperous and successful 2016!