Stock Market Crash: Here’s a Blunt Reality Check of Investors

Stock Market CrashCould Weak Earnings Spark a Stock Market Crash in 2016?

Weak corporate earnings could result in a stock market crash in 2016, dashing the mainstream belief that the U.S. economy is in a recovery.

The Federal Reserve’s uncertain interest rate policies and lower commodity prices have jointly served as catalysts to spark market speculations. Global economic and political crises have further augmented stock market volatility, with the S&P 500 index plunging and then bouncing back in an erratic fashion in the last year. The Fed has yet again decided to postpone the impending interest rate hike, potentially leasing to a stock market crash in 2016.

The postponement, which followed the lower-than-expected jobs figures, sparked a rally in the market which has continued on Monday, with the S&P 500 and Dow Jones Industrial Average both posting gains. Last week has been particularly great for the S&P 500 index with gains of around five percent in just a week. But are we really in for a long-term rally or is it just a temporary frenzy that will soon fade away?

Dismal Earnings Reflect America’s Slow-Motion Economic Collapse

The answer will become obvious as the third-quarter corporate earnings reports start rolling out. But here’s what we know for certain. Performance of the entire S&P 500, except the consumer discretionary sector, has been abysmal year-to-date. All other sectors including consumer staples, energy, healthcare, financials, industrials, technology, materials, telecom, and utilities have posted declines this year. In the recent quarter, S&P corporate earnings suffered primarily from declining commodity prices. The energy sector, hit by lower oil prices, caused the biggest damage by pulling down the average figures.

Following the Q2 earnings, analysts have lowered their estimates for the third quarter, so it’s likely that some companies are able to beat the lowered expectations. Four S&P 500 companies have so far posted third-quarter earnings of which two have beaten analyst forecasts, one has missed, and one has barely met the expectations.

S&P 500 Companies EPS Surprise
Costco Wholesale Corp (NASDAQ: COST) Beat
Paychex, Inc. (NASDAQ: PAYX) Beat
McCormick & Company, Inc. (NYSE: MKC) Miss
Micron Technology, Inc. (NASDAQ: MU) Met

For the third quarter, expect energy, materials, and industrial sectors to take the biggest hit. Healthcare, technology and consumer discretionary (automobiles, restaurants and retail) sectors are relatively in a better position. But brace yourselves for net negative earnings surprises across the board and a stock market crash!

Here’s the Bottom Line for Investors

One indicator that confirms a likely stock market slump is investors fleeing the stock market to liquidate their investments into cash. The third quarter saw investors moving from stocks to cash. (Source: Fed Up Investors Yank Cash From Almost Everything Just Like 2008, Bloomberg, August 28, 2015.) And to top it off, the August slump in S&P also sparked investor interest in bonds contrary to stocks. Deteriorating corporate earnings will further hurt investor sentiments.

More substantive evidence of a slump comes from the index’s technical trend. The S&P 500 has shifted below its 20-day and 200-day moving averages during the later half of the third quarter, indicating that a downtrend has begun. Historically, the S&P index has slid in a similar fashion in the last recessions of 2008 and 2001.

S&P500 Large Cap Chart

Chart courtesy of www.StockCharts.com

In a nutshell, earning are expected to decline by 5.1% in the third quarter, as 76 of the S&P 500 companies have so far issued negative EPS guidance, with only 32 giving a positive outlook. (Source: FactSet Earnings Insight, FactSet, October 5, 2015.) Eyes are not set on PepsiCo, Inc. (NYSE:PEP), Yum! Brands, Inc. (NYSE:YUM) and Alcoa, Inc. (NYSE:AA), which post Q3 earnings this week.

If these reports are weak, look around below. Dismal corporate profits could spark a stock market crash in 2016.

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