4th Quarter 2015 Outlook
I recently read an article by Eric Parnell, CFA and would like to share portions of it with you. It provides a very good outlook for the 4th Quarter 2015. I trust you will find it as interesting as I did.
Where We Are Now
It was an ugly quarter for stocks from all around the globe. A variety of pressures weighed on markets in recent months including concerns about a growth deceleration in China (NYSEARCA:GXC), a renewed plunge in commodities prices (NYSEARCA:DJP), uncertainty associated with the timing of interest rate increases from the U.S. Federal Reserve and general worries about the global economic outlook all helped contribute to poor results for stocks worldwide.
Leading the move to the downside were emerging market stocks (NYSEARCA:EEM), which plunged by more than -16% during the quarter. Bleeding in markets like China (NYSEARCA:FXI) and Brazil (NYSEARCA:EWZ) helped contribute to the downside. Developed international stocks (NYSEARCA:EFA) fared little better in falling by more than -10% with markets in Japan (NYSEARCA:EWJ) and Germany (NYSEARCA:EWG) falling in the low double-digits. And while U.S. stocks performed relatively better, they too were down nearly -7% for the period as measured by the S&P 500 Index (NYSEARCA:SPY).
The impact associated with these recent declines were notable. First in the U.S., the uptrend in stocks that had been intact since 2011 has now been broken. This suggests that the third longest bull market in history may be coming to an end and that we may now be entering a new corrective phase in stocks.
Supporting this notion from a fundamental standpoint is the fact that corporate earnings continues to fade with projections for annual earnings growth to decline through the remainder of the year and growth projections for the first part of 2016 being revised lower now to the low single digits (of course, they are then forecast to miraculously explode higher by the end of 2016, but then again even more robust numbers were originally forecast for 2015 and we can now see how well those projections actually played out in reality).
Also notable is the fact that annual revenue growth has also turned negative for two quarters and counting. While much of this sales decline has come from the energy (NYSEARCA:XLE) and materials (NYSEARCA:XLB) sectors, it is also notable that comparable readings for technology (NYSEARCA:XLK) also recently turned negative and industrials (NYSEARCA:XLI) are grinding to a halt. All of this along with a price-to-earnings ratio on the S&P 500 Index still hovering at a historically lofty 20.2 times earnings suggests that the stock market may struggle to reclaim its uptrend and reach new highs in the coming months.
Moving over to Europe (NYSEARCA:HEDJ), it was not long ago in the early part of the year that markets across the continue were ebullient over the announcement and subsequent launch of the ECB’s QE program. But this excitement is now gone, as the correction over the past couple of months has completely wiped away all of these QE gains.
A similar story could be said about Japan (NYSEARCA:DXJ). The recent correction has this market threatening to break below the initial peak achieved following the launch of the Bank of Japan’s money supply doubling stimulus program back in early 2013. Moreover, Japanese stocks have already effectively given back all of the gains reaped following the Bank of Japan’s surprise announcement at the end of last October that they would be adding even further to this already aggressive monetary policy program.
And then there is China, whose stock market despite all of its policy interventions in recent months has already surrendered its 200-day moving average and its clinging to its ultra long-term 400-day moving average as a potential last line of defense before breaking its way back to the levels in and around 2000 on the Shanghai Composite from just last summer before the People’s Bank of China entered into its massive stock market boosting effort.
A key takeaway from market performance over the past quarter is the following. After nearly seven years of market excesses thanks in large part to global monetary policy largesse, it appears that we may have finally discovered that bounds actually do exist in the ability of central bankers to artificially inflate asset prices. As for the economic benefits and costs of these efforts, the results have been marginal at best – the monthly jobs report for September announced on Friday was just the latest piece of evidence supporting this point – and have placed the global financial risk at meaningfully greater risk for future potential uncertainty. Such is the unfortunate outcome when the global economy becomes a laboratory for monetary policy experimentation.
Where We May Be Going Next
Despite all of this negativity swirling around the stock market, the near-term outlook as we enter the fourth quarter may actually hold some promise. Not that the mounting challenges facing the global economy are suddenly going to go away, because they are not. In fact, they are only likely to get worse. But it is important to note that unlike bull market phases where stocks can rise for months on end seemingly without interruption, stocks typically do not fall in a straight line when they enter into a prolonged corrective phase. Instead, they “dip” lower and then “rip” higher with successive lower highs and lower lows set along the way in the process. And amid a solid and ongoing “dip” that started in July, we may now be overdue for at least some sort of “rip” as we move through the seasonally welcoming final months of the year.
The last sixty-five years of stock market history provide support to the notion that we may see stocks register a decent “rip” before the year is out. Stocks as measured by the S&P 500 Index declined by more than -8% during the months of August and September. This marked the fifteenth time since 1950 that stocks have fallen by -5% or more over the months of August and September. In eleven of these past fourteen instances, or 79% of the time, stocks posted gains during the month of October. And looking further out toward the end of the year, in ten of these past fourteen instances, or 71% of the time, stocks generated gains over the last two months of the year in November and December. Lastly and perhaps most notably, when combining this all together, stocks were higher in Q4 in twelve of the past fourteen instances, or 86% of the time, after falling by more than -5% in August and September. In other words, when stocks have experienced a “dip” to close out the summer, history has shown that such corrections are followed by a “rip” at some point during the fourth quarter.
So what were the two exceptions?
The first was in 1957 as the stock market was entering into the bottoming process of the short and shallow bear market that had began back in August 1956 but really picked up speed to the downside in the summer of 1957.
The second of course took place in 2008, as the stock market was working its way toward the final bear market lows that would eventually come the following quarter in March 2009.
Overall, investors should expect some measurable bounce as we progress through the fourth quarter of 2015. Such a rally may not start right away, as it would not be surprising at all to see stocks either retest the August 2015 lows at 1867 once again, the October 2014 lows at 1820 or an even lower level below these floors first in the coming weeks before finally bouncing. And if stocks do continue lower and are unable to post positive results in the final quarter of the year, it suggests that either a more sustainably might be right around the corner or that the forces driving stocks to the downside are notably powerful and may prove difficult to reverse.
Implications For Fed Policy
But let’s assume that stocks follow the historical pattern and show some life to the upside in the fourth quarter. This has important implication for Fed policy. Not because it should, for the last I looked the Fed’s dual mandate is full employment and price stability, not ensuring that the S&P 500 Index is trading higher on any given trading day. But Fed policy makers have consistently demonstrated themselves to be highly sensitive to the movements of the stock market at any given point in time. Thus, if the stock market starts to “rip” and is showing signs of stabilizing, even if the S&P 500 Index is still trading below its May and July 2015 highs, it may provide the FOMC with enough confidence come December to finally claim that elusive first rate increase off of the zero bound before the global economic lights go out.
What about the lousy September jobs report we just received on Friday? Here’s the thing. The September jobs report is the headline du jour for early October. But the sentiments coming from this report may be a distant memory by the time December rolls around. For one has to look no further than earlier this year to see why. In early April, the March jobs report came out and the data was lousy, which had markets quickly jumping to the conclusion that rate hikes were off the table. But then came early May and the April jobs report, which was surprisingly strong, and just as quickly the notion of Fed rate hikes were fully back on. One sincerely hopes as the financial media might suggest that the most autonomously powerful policy makers in the world at the U.S. Federal Reserve are not making policy decisions based off of the latest headline data points that are subject to heavy revisions in the future, but given their urgency to send somebody to the podium every time the S&P 500 Index is down more than a percent or two, maybe just maybe this is actually the case. Regardless, a recovering stock market come December would make the Fed’s path easier to squeezing in a rate hike before the year closes out.
What Any “Rip” Means For 2016
Just because stocks might experience a relief rally in the fourth quarter of 2015, investors should not mistake this renewed sign of market life as a sign that the next great upside rally is underway. For outside that elusive sustained economic recovery finally taking hold or the Fed performing a complete reversal and shifting from trying to raise interest rates to launching QE4 that includes daily Treasury purchases, the longer-term trend for the stock market remains to the downside heading into 2016.
The following is a key technical level to watch on any sustained rally in the S&P 500 Index during the fourth quarter. The ultra long-term 400-day moving average is a resistance level that the S&P 500 Index must reclaim on any future bounce to sustain the bull market higher into 2016. Stocks have already attempted to break out back above this technical level on two separate occasions in recent weeks and failed in both attempts. The slope of the bounce from levels just above the late August lows over the past four trading days suggest that the S&P 500 Index may soon be making a third run at a break out above this key technical level. If it does so, particularly while the 400-day moving average remains upward sloping as it still is today, then hopes would remain strong that the third longest bull market in history is still alive and well. The next level to then watch would be the now downward sloping 200-day moving average. But first things first.
But if stocks attack this 400-day moving average technical resistance level and fail once again, particularly if the slope of this line also starts turning negative, the last 90 years of market history would suggest that a much more sustained and prolonged downside move in stocks is only just starting to get underway.
With this possibility in mind investors may be well served to view any return to the 400-day moving average in the coming months as an opportunity. If there are any stock positions that one has been considering selling, a return to this technical level may be an opportune time to do so. For if the market does continue higher from there, the market will always offer attractive positions to install as replacements. Conversely, if one has been contemplating the idea of establishing a more assertive inverse strategy relative to the broader U.S. stock market under the idea that stocks and high yield bonds may be set to continue lower following a near-term “rip”, such a return to this 400-day moving average level may provide a particularly good entry point for executing on such a strategy.
It promises to be an interesting quarter worth watching in the fourth quarter of 2015. Global capital markets including U.S. stocks have arrived at a key inflection point. Either stocks will find their footing and reclaim the bull market path, or they will continue their recent “dip” and “rip” cycle in starting to build up steam to the downside. Barring some extraordinary monetary policy announcement such as QE4 from the Fed, probability currently supports the latter downside move over the intermediate-term to long-term versus the former return to long-term rally mode. But investors should also recognize that probability for a short-term rally is also high, and they should not view any recovery in stocks over the coming weeks as an all clear signal. Instead, they may be best served to use any such rally as an opportunity to position for the next move lower. Exactly how any such rally plays out will go a long way in determining the prudence of such action. Stay tuned for what is set up to be an exciting finish to 2015.
After reading the above analysis, it confirms my belief that we must keep our powder dry and watch for market movements that may signal which direction we need to move. I am cautiously optimistic and will look for better entry points to take advantage of good earnings reports during the last quarter of 2015.
We moved to cash starting August 20, 2015 enabling our portfolios to avoid much of the correction of August 24th and 25th. Subsequently, I bought small position in good companies such as DIS, ATVI, FB, FL, SKX and UA. We are up approximately 4.0% on these equities currently.