The long-term moving averages including the 200 day moving average which is the most closely watched, has rolled over and is trending downward. This usually precludes further declines in price. Prior to a further decline however, prices typically rise to test the 200 day moving average. If prices do increase to the 200-day average and drop from there, it will be an ominous sign of further market weakness.
We expect continued volatility this year due to margin calls and the continued popularity of ETF’s and Index Funds which has helped exasperate moves to the upside and downside for stocks in those indices.
ETF’s now control about 40% of trading volume and are often used by hedge funds and institutional investors for leverage. Due to the high amount of leverage currently being used, if margin calls are issued, it will spill into the general market creating some liquidating calls. There is speculation that this is already occurring.
This could lead to more investors cashing out leading to a large downward move. Liquidity issues in ETF’s helped explain the flash crash in 2010.
As mentioned, we continue to see a sustained decline in corporate profit margins. Corporate earnings growth itself is at its worst since 2000. Companies have recognized this trend, are bracing for a slowdown as they scale back investment plans leading to demand for commercial and industrial loans to decrease by over 10% in 2016. While there is some consumer strength I haven’t seen anything to reverse the continued decline in revenues or profit margins.
It’s difficult to find anything other than pockets of consumer spending strength and labor price increases that bode well for further stock price gains over the following few months. Low commodity prices signal that lower growth is here to stay for a while and businesses will not be expanding as quickly.
Years of easy money have formed a credit crisis that is finally being exposed. Sovereign wealth funds are pulling their money out of equity markets and the yield curve is flattening which will further hurt bank earnings. This has a led to fear of the unknown as we travel into uncharted territory after years of fiscal manipulation and nations drowning in debt.
The central banks have also left themselves with limited ammunition to continue propping up their respective stock markets. The exception to this being the extreme of negative interest rates. The European Central Bank, Switzerland and more recently Japan have already gone to negative rates. This, along with exposure to emerging market debt has led to unintended consequences including additional financial stress on large financial institutions leading to large sell-offs in that sector.
Looming over all this are the mega bets vs. China’s currency – the Yuan, signaling a significant possibility of imported deflation which will further dampen corporate profits.
I’ll leave you with the following. Art Cashin, who I respect immensely for his level head and wisdom from years of market experience shared the following ominous insight. “Jason Goepfert, the outstanding pilot of Sentiment Trader dug into his incredibly extensive files to uncover a rather rare condition. He noted that the indices have had two 10% corrections in a rather short span. That has only happened three times in the last 100 years. Unfortunately, those occurrences were in 1929, 2000 and 2008. As you may recall, those were not particularly good years for the bulls.” While 3 occurrences are too small a sample set to draw conclusions from, I feel it is worthwhile to incorporate into my overall analysis on the current state of the markets.