2016 Stock Market off to a Stumbling Start, Some See Omen

By: David Haggith | Tue, Jan 5, 2016
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Omen

As investors cried, "Good riddance to 2015, a terrible year for stocks," 2016 decided to start out worse. The Chinese stock market got the dry heaves again, and the rest of the world's markets got sea sick. Stock-market superstition says, "As goes the first day, so goes the year." Let's check that out.


The China Syndrome ... again

The Chinese market threw up all over the place this Monday, in anticipation of next Monday when the Chinese planned to remove the safety brakes they applied last summer when their market collapsed. In other words, the Chinese were going pretend their stock market is a free market once again.

The Chinese market lost half a trillion dollars of value on Monday, and trading only stopped plummeting when one of the old safety brakes kicked in. That brake closes the market if a decline reaches 7%. Chinese factory data also fell for the tenth month, and fell further than expected by economists. Monday's wipeout leaves China now stuck on how to unwind the safety mechanisms that effectively socialized the market and ended nearly all of its freedom.

A flare-up in tensions between Saudi Arabia and Iran on Monday also caused market concern, as Saudi Arabia executed a shi-ite cleric, setting the wannabe Islamic caliphate on fire. That became real fire at the Saudi embassy in Iran when Islamic protestors threw Molotov cocktails at it. As a result, Saudi Arabia closed its embassy in Iran and terminated diplomatic ties.

In response to China's meltdown, especially, as well as to growing heat in the Middle East, all the stock markets of the world fell sharply on Monday. Hong Kong plunged 587 points. Japan fell 282. Germany dropped 459, and Europe overall had its worst start of the year since stock markets began. Some see that as a bad sign of things to come, which I'll get into further on.

In the US, the S&P 500 got off to the worst start of a new year in fifteen years, it's sixth-worst start of all time. The sell-off was broad, bringing down all ten sectors of the S&P. Both the S&P and the Dow dropped about 1.5%, while the Nadaq, which had been performing better than the other two indexes because it is weighted toward high tech, lost 2.1%. The volume of trades also shot upward. All of this proved that economists who have been saying the US is fairly immune to whatever happens in China are blind. The US is, in fact, not the least bit immune to all that is happening in China.

"We've had a number of negatives out there in the U.S., and China is a reminder that there aren't many things to be bullish about going into this year," said Michael O'Rourke, chief market strategist at JonesTrading Institutional Services LLC in Greenwich, Connecticut. (The Washington Post)

The Dow got off to its lowest opening of a new year since the Great Depression; and, at it's worst point in the day, it was down 487 points. It recovered some of that in the afternoon to close down 276 points. Even that decline made for the worst start of a year for the Dow since 2008 when the Great Recession began.

In what is considered another bearish sign, the S&P 500 crossed below all of its major trend lines -- its twenty-day moving average, it's fifty-day moving average and its hundred-day moving average. In other words, it has now broken all barriers.

Since I don't put much stock in stock charts (though many investors do), the most predictive aspect of Monday's crisis to me is where the carnage happened. Through most of 2015, only ten stocks held the Dow Jones Industrial Average and the S&P 500 above water. Of those ten, the so-called "FANG" members of the club -- Facebook, Amazon, Netflix and Google's parent (now called "Alphabet") -- tumbled 3.6 percent. Amazon fell 5.8%. Netflix, 4% because its stock was downgraded due to rising production costs and slowing growth in the US.

I say this is more predictive than crossing chart lines because more of the top-ten stocks joined Apple in its fall. That they took a bigger hit than many other parts of the market shows that they are now vulnerable, whereas they seemed to be coated in Teflon through much of 2015. If the only stocks that have been keeping the major indexes above water give way, then all of the indexes are finally going to fall ... as I've already said they now will. They are showing clear evidence of cracking up under stress now that the Fed's inflation of the stock market has ended.

As a result of the decimation that happened Monday in the top-ten, the world's five richest people lost $8.7 billion in one day. Jeff Bezos, founder of Amazon, Bill Gates and Warren Buffet were among the five. Of course, they could make it all back tomorrow. Such is the life of a stock billionaire.


The Federal Reserve remains optimistic

Of course.

One Fed official, Loretta Mester, said she didn't see the problems in China as being any significant risk to the Fed's forecast for the US economy, but not everyone agreed:

Global spillovers from China's slowdown have been "much larger than we could have anticipated," affecting the global economy through reduced imports and weaker demand for commodities, IMF Economic Counselor Maurice Obstfeld said in an interview posted on the fund's website. (Newsmax)

Another Fed board member said that he foresees the likelihood of five rate hikes in 2016, rather than the four that have been talked about. The Fed seems determined to show it believes in the strength of this thing it calls a "recovery.' But that's how the Fed was in 2007 and 2008, too.


Read the book the movie was based on: The Big Short tells how things fell apart in 2007 and 2008.


The Omen


Stock-market superstition

The decline in the US stock market that began in the second half of Demember accelerated quickly at the start of the year. Superstition in the stock market says Monday is Groundhog Day for stocks; but how predictive has Monday actually been? Does it give hope to my bet that the US stock market would crash after the Fed raised rates at the end of fall?

If one goes by the S&P 500, there may be no truth to that superstition. A drop in the S&P on the first day of the year has been matched by a decline for the whole year almost exactly 50% of the time. That 50/50 split would make it seem the first day doesn't portend much. However, one has to factor in that there are quite a few more up years in stocks than down years. So, if the day did not foreshadow what is to come, a down day should be followed by more up years than down years.

What if the day is not just down, but is one of the six worst opening days in history, as Monday was? Still no difference. Of the six worst opening days for the S&P 500, three of those years saw stocks go down and three saw them go up. However, two of the three years that went down following a bad start were years when the stock market had it largest crashes. And, again, there is that fact that the odds of an up year should be better than the odds of a down year.

Statistics for the Dow lean little more toward opening day being an omen of what may come. When the Dow trades down on its opening day of the year, the year as a whole goes down 49% of the time, about like the S&P. However, when the Dow trades up on opening day, the year only goes up 26% of the time. Since there are more up years in the stock market than down, that means the Dow fails miserably at predicting up years, but tends to match on down years. According to Mark Hulbert, a senior columnist at MarketWatch, the Dow's correlation between down opening days and down years statistically has "95% confidence level" of being predictive about 75% of the time.

Dow Jones statisticians ... point out that the last three times the market has slumped at the start of the year--including 2000, 2001, and 2008--stocks saw a negative return of 15.7%. (MarketWatch)

So, the Dow is three-for-three in the past two decades.

Regardless of statistics, I think it is notable when a year starts out bad simply because most of the time the stock markets of this world start out positive in the new year when people are feeling optimistic about new beginnings. If the previous year was good, they see that as a strong foundation for continuing on. If the previous year was bad (like 2015), they feel relieved to be starting a new one in order to have a fresh crack at things. Since the first day of the year is positive two thirds of the time, one has to wonder if something is going bad if a day that heavily weighted to the positive goes wrong, especially when it goes terribly wrong like it did on Monday:

"My entire screen is blood red -- there's nothing good to talk about," Phil Orlando, who helps oversee $360 billion as chief equity market strategist at Federated Investors Inc., said around noon in New York, as losses in the Dow Jones Industrial Average approached 500 points. "On days like today you need to take a step back, take a deep breath and let the rubble fall." (Newsmax)

While it was the worst opening day in three decades, we'll have to see how more of the month goes before we'll know if I get to keep writing my blog or not. Even though opening day has not shown itself to have a lot of predictive value, the direction the month of January goes matches up with how the year goes 75% of the time. None of my predictions for the global economy and US stocks are based on things like this anyway. They are based on the fundamentals. So, while it proves nothing, it looks generally positive that putting my money where my mouth is is not going to cost me my blog. (As I said in my previous article, somebody making predictions needs to have some skin in the game.)

The main thing is that Monday went as I anticipated it would now that bad news is bad news for the stock market because the lift of Fed stimulus is gone. As I've been saying, there is a lot more bad economic news in the hopper right now than good since many countries are going into recession, many stock markets are already crashing, China is continuing to slow down, oil is still falling with an abundance of indication it will far further, and the Middle East is continually getting hotter.


China's stock-market meltdown is certain to continue

Monday certainly the kick-off for 2016 that Wall Street wanted. China is one of the major headwinds that I said would blow the stock market around once the US market untethered from the Federal Reserve, and I have absolutely no doubt that China will batter the markets some more.

China's markets stumbled out of the gate again Tuesday, falling 2% in early trading, requiring the People's Bank of China to pump an instant $20 billion! into another market rescue. It also pressured the China Securities Regulatory Commission to announce it will not remove its ban on major investors next Monday, as it had planned to do.

The latter stemmed the panic by assuring small players that all big plays will remain frozen. China's play says that it believes a free market would self-destruct. China is now ensnared by a catch-22 situation as it tries to save its market from crashing further at a time when it had planned to remove restrictions put in place in August when nearly $5 trillion was wiped out of the Chinese stock market.

This appeared to have paid off after a subsequent partial market rebound, yet it always left a worrying overhang both from resulting heavy state ownership and the imposition of a six-month ban on major shareholders (over 5%) from selling positions. With that six-month moratorium ending [after] this coming Friday, investors were spooked that there could be an avalanche of pent-up selling. And this time around will the government still be around to come in as buyer of the last resort...? Money mobilized to buy stocks has been estimated at 5 trillion yuan or 10% of gross domestic product.... President Xi Jinping ... was quoted in the mainland press saying that China will face increasing challenges over the next five years for which strong stimulus to boost development is no longer the solution....Given these shifting priorities, it is hardly a stretch to conclude that it would be politically difficult for Beijing to keep extending unlimited funds to bail out equity investors. Ultimately when Beijing created a market where it was the only buyer, it also placed itself in an extremely exposed position. If investors suspect the state is no longer ready or able to step in, expect Chinese equities to fall fast. (MarketWatch)

Beijing now appears unable to unwind its tight restrictions on what was formerly a stock market. It's ham-fisted rescue in August caused many players to stay out of the market, lest they become trapped by the new rules. By freezing all of its seriously falling shares as it did and locking the main players into the market, Beijing has allowed more ground to slump out from under those its economy cooled further. That has left investors to feel they are hanging over air, locked into shares that are certain to crash the second China removes trading restrictions. Bank of America Merrill Lynch expects the Shanghai Composite index to fall another 20% by the end of the year.

What happened this Monday can be seen as a mere hint of the carnage that would occur if major traders were unlocked from their Chinese stocks next Monday. The scenario set up by Beijing adds new meaning to "stocks and bonds." With a gun to their heads, some Chinese corporations have pledged they will not sell shares for a year if and when the government's restrictions are removed.

So, strap yourself to the saddle because this market is likely to buck a lot more in the days ahead. Global markets on Tuesday held flat, leaning slightly negative, as if holding their breath while peering into the abyss as investors watched China's intervention, wondering what comes next.

Not surprisingly, the fury on Monday sent gold up -- a sign that some investors were seeking a safe haven. Outlook for gold has been somewhat bearish because of the Fed's interest-rate increase. In a normal world, rises in interest tend to syphon investors out of the gold market as better interest in relatively safe bonds makes another safe haven investment even better.

The stock route, however, also sent investors to bonds, driving yields down for bonds. So, really investors routed to both bonds and gold for marginal safety. Part way through Tuesday, the market is doing a lot of bucking, mostly below the starting line.

 


 

David Haggith

Author: David Haggith

David Haggith
The Great Recession Blog

David Haggith

My path to writing this blog began as a personal journey. Prior to the start of this so-called "Great Recession," my ex-wife had a family home that was an inheritance from her mother. I worked as a property manger at the time, and near the end of 2007, I could tell from rumblings in the industry that the U.S. housing market was on the verge of catastrophic collapse. I urged her to press her brothers to sell the family home before prices dropped. The house went on the market and sold right away -- and just three months before Bear-Stearns and others crashed, taking the U.S. housing market down for the tumble. Her family sold at the peak of the market.

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