It’s been a rough start to the New Year.
We saw the worst opening week in the market’s history in January. Since then, the S&P 500 is down a bit more than 8%. That’s comparable to the 7.9% decline we saw in January 2008 – the year the financial crisis began.
But it’s not the worst January in recent memory. Back in January of 1990, we saw a peak-to-valley drop of more than 11.4% to start the year. By September of that year, the market had dropped 20%.
Then, like now, the market was reeling from several economic headwinds, such as the doubling of oil prices virtually overnight (thanks to Iraqi incursion into Kuwait). The economy slowed from 9.1% in 1Q1990 to a low of 0.4% by the end of the year. It was a bleak time. Sentiment was horrible and investors were panicking.
But just 13 months later, the S&P 500 was breaking out to new all-time highs.
So this begs the question…
Will 2016 see a bounce similar to what we saw in 1991?
I don’t think so. Here’s why…
Back in December 2015, we updated our clients with a warning about an impending drop in the S&P 500. At the time, the broad market index was at 2,064. But we expected to see a move to 1,800 followed by a bounce higher.
On January 20th, we saw the S&P hit 1,812 (intraday). Since then, it has bounced back, just as we expected. However, the index has been unable to hold its 20-day and 50-day moving averages, leading us to expect the market to fall by year’s end.
Now, that doesn’t mean it’s a lock. You see, the first step to see a move higher from here will be a retest of January’s intraday low of 1,812. And if that low doesn’t hold, expect a slow grind lower to about 1,600.
Fueling our pessimism are three concerns that lead us to believe a mini bear market similar to what we saw during the ’90 – ’91 period could be just ahead.
First are the job reports for December 2015 and January 2016, which on the surface, looked good. While the December number beat expectations, the January number fell short, although it posted a respectable increase.
Or so it seemed…
Like so many things coming out of Washington D.C., the numbers were phony.
You see, the Bureau of Labor Statistics (BLS) performs a seasonal adjustment to the employment numbers. This accounts for events such as weather, major holidays, and school schedules.
But taking out the BLS’ fictional adjustments, we find that the non-seasonally adjusted numbers for each month told a far different story. And it’s not a pretty one…
In November 2015, the BLS reported there were 144.180 million jobs in the United States. A month later, that figure rose to 144.191 million jobs – an increase of just 11,000 jobs. That’s a far cry from the 292,000 new jobs reported by the government.
But that’s not the end of it. Since that initial report, the BLS has revised those numbers. Now, the BLS says that the number of jobs in November 2015 was actually 144.122 million, while the adjusted December total was 144.112 million. That’s a decline of 10,000 jobs from November to December!
But wait, there’s something more sinister happening here…
Today, the BLS announced the creation of 151,000 new jobs for January 2016. Now, the BLS numbers are preliminary and will likely see another revision, but until then, they’re frightening.
You see, the BLS report indicates there were just 141.123 million jobs in the United States at the end of January 2016. That’s a decline of almost 3 million jobs in the last two months.
These numbers suggest the U.S. economy isn’t as strong as the political classes would have you believe. And we remain concerned that the labor weakness has not yet been priced into the stock market.
But the employment picture isn’t our only concern. The sharp drop in oil prices hasn’t been fully priced in either.
Now, lower oil prices are generally a very good thing for individuals, corporations, and most economies. You certainly don’t need a Ph.D. to figure out that low energy prices are a plus to an economy.
But the slide in oil is much worse than expected. It now looks like it could settle near $20 per barrel. This fall will negatively impact S&P 500 earnings for far longer than originally speculated.
And the severity of the decline will crush the junk bond market. Just like in 1990, this will create a liquidity crisis that will bleed over into the stock market.
And lastly, there’s China…
On January 18th, China reported GDP growth of 6.9%. We have a word in economics for China’s claim – poppycock!
That number is pure fiction. You see, based on China’s rate of electricity consumption, China is growing at just over 2% per year.
And the country cannot long pay its bills at that level of growth. So, in order to goose its economy, China will likely devalue its currency by another 15%.
This will automatically make American-made goods 15% more expensive to Chinese consumers, further crimping sales for American companies and reducing earnings for the index.
But a devaluation will also send a clear signal to other emerging market economies that a race to the bottom has been engaged. A global recession is almost unavoidable on that basis alone.
And taken in combination with the strong evidence of slowing U.S. employment and the continuing slide in oil, the stock market is significantly overpriced at current levels.
As such, we will continue to short this market.