2016 will be an interesting year no matter what. Which direction it goes depends on whom you ask. Bankers see the worst start of the year for stocks as an emotional response to economic news, which they believe is really quite strong. But I believe the elements are in place for a recession in the U.S. economy and a stock market crash in 2016.
U.S. stocks are anemic. Stocks are overvalued. Corporate earnings and revenues are down. Oil prices are in freefall. The global outlook is weak. China’s economy is deteriorating. Tensions are rising in the Middle East.
Despite the moribund outlook, there are steps investors can take to grow their retirement portfolio and profit from the stock market crash headed our way.
Banks See 11% Upside in S&P 500?!?
Leave it to the banks, which make money on deposits from investors, to be overly optimistic on the direction the stock market will take. Instead of looking at the data, they blame the plunge in stocks and increased volatility on emotional responses.
According to Goldman Sachs, the fair value for the S&P 500 index is 2,100. It’s been a while since the S&P 500 last saw levels like that. Well, not that long ago, it closed above 2,100 on December 1, but it feels like a long time ago. Since then, the S&P 500 has fallen 10%. In 2016 alone, the S&P 500 has fallen roughly six percent. (Source: “Goldman Sees 11% Upside in S&P 500 After an `Emotional’ Selloff,” Bloomberg, January 14, 2016.)
Keep in mind that after three years of double-digit growth, the S&P 500 closed out 2015 down 0.7%. That was a year Goldman Sachs predicted the S&P 500 would deliver a “modest total return of 5% in 2015,” with the U.S. economy expanding at a brisk pace and corporations boosting sales. (Source: “The Stock Market In 2015 Will Be… Meh,” Business Insider, November 14, 2014.)
U.S. companies didn’t exactly boost sales in 2015. The estimated earnings decline in the fourth quarter of 2015 is forecast at -5.3%. At the end of the third quarter, the forecasted earnings decline for Q4 2015 was just -0.6%. If the index reports a decline in fourth-quarter earnings, it will be the first time the index has seen three consecutive quarters of year-over-year declines since the first quarter of 2009 to the third quarter of 2009. (Source: “Earnings Insight,” FactSet, January 8, 2016.)
The estimated revenue decline for the fourth quarter of 2015 is -3.3%. If this is the final revenue decline for the quarter, it will be the first time the index has seen four consecutive quarters of year-over-year revenue declines since the fourth quarter of 2008 through the third quarter of 2009.
If anything, one could argue that investors propped up the stock market in 2015 due to emotional responses. Who wants to bet against the U.S. economy? Still, one needs a heavy dose of skepticism when listening to what the banks predict about the economy, especially when they wax eloquence about the growing economy and corporate profit growth when the data seem to suggest otherwise.
Still, since the stock market has always rebounded—and will again—anyone can call for an 11% upside at some point.
This Generation’s Biggest Stock Market Crash on Its Way
Are you a contrarian just because you read the data? If so, I’m a contrarian. I’d rather be a perma-bull riding profits higher and higher, but I can’t be. Not in this economic climate.
Since the markets bottomed in March 2009, the stock market rebounded at the hands of the Federal Reserve and its generous bond-buying program. Since 2009, the stock market has climbed steadily higher despite mediocre earnings and growth. On real earnings and growth, a company can only champion cost-cutting measures and share buybacks for so long.
Regardless, the Federal Reserve’s easy monetary policy helped send the stock market higher and higher, propping up share prices. Now that the Federal Reserve has stopped buying bonds and started to actually increase rates, the props supporting the stock market have been removed.
The artificial growth that came at the hands of the Federal Reserve will see the light of day and the stock market will crash. Essentially, the Federal Reserve tried out a $3.5-trillion experiment on the U.S. economy with no exit strategy.
And its short-term vision is paying off.
Over the first eight days of trade in 2016, global stock markets have lost $3.17 trillion—the biggest decline for global stocks since October 2008’s $5.671 trillion decline. More than half of that loss belongs to Wall Street, with U.S. stocks off $1.77 trillion and non-U.S. stocks down $1.4 trillion. (Source: Howard Silverblatt’s Twitter feed, January 13, 2016.)
It’s possible the Fed’s quantitative easing (QE) policy might have worked if the U.S. was an economic island. But it’s not.
The Chinese economy is doing terrible. The rest of the countries that make up the BRICS—Brazil, Russia, India, and South Africa—could also derail the global economy. Plus, low commodity prices are having a lasting effect on the North American oil industry, something that would have seemed unthinkable just a year ago.
Stocks Continue to Be Seriously Overvalued
Corporate America is sending out warning signs but still, the stock market marches higher and higher. While Goldman Sachs is happy telling clients the S&P 500 should be near 2,100, others are not quite as optimistic.
According to the CAPE PE ratio for the S&P 500, the index has a value of 24.4. This means that for every $1.00 of earnings made, investors are willing to pay $24.40. The only time the index has really been higher was in 1929 and 1999. (Source: Yale University Economics Department, last accessed January 14, 2016.)
If we compare the current valuation of the S&P 500 to its historical average of 16.59, the stock market is overvalued by roughly 67.9%.
The market cap to GDP ratio is, according to Warren Buffett, “probably the best single measure of where valuations stand at any given moment.” A reading of 100% suggests stocks are properly valued. (Source: “A Fractional Increase in the Buffett Valuation Indicator,” Advisor Perspectives web site, last accessed January 14, 2016.)
Today, the Warren Buffett Indicator sits at 107.6%, pointing to a market that is modestly overvalued and is likely to return 1.8% a year from this level. Since the beginning of 2016, the ratio has fallen 11.5%. Still, the ratio has only been higher twice since 1950—in 1999 and at the end of 2015.
Central Banks Run out of Tricks
Eventually, earnings and revenues will catch up to stock valuations and the global economy will weigh on fragile stocks, sending them reeling. And this is after central banks from around the world collectively spend trillions to kick-start their economies.
The fact of the matter is that the global economy is no better off than had the central banks done nothing. What will central banks do when global stock markets crash? Nothing. Interest rates are already low everywhere. They’ve run out of tricks to prop up the economy. What’s left, going into reverse interest rate territory?
Doing anything other than raising rates would show their strategies failed and even they’re not bullish on the future of the global economy. So slow and steady is their mantra, no matter what. The end result will be a stock market crash and another recession. How low it will go is anyone’s guess.
What Investors Need to Know Before the Stock Market Crash
Our prediction is that today’s stock market is setting up for a huge tumble…a collapse that will make the stock market crashes of 2008 and 1929 look like a cake-walk.
Corporate profits and sales are contracting, manufacturing is down, wages are still low, debt levels are up, an eye-watering number of Americans still receive food stamps, and pessimism is up.
The action on Wall Street is just as telling. Corporate insiders are dumping stocks at a record pace, stock advisor bullishness it hitting multi-month highs, the VIX is pointing to a stock market reminiscent of October 2007, public companies continue to prop up earnings with record buybacks, bond funds are snapping up stocks, and NYSE margin debt has surpassed the pre-financial crisis record.
With the global economy teetering on a precipice, the Federal Reserve raising rates, and the Bank of England waiting to do so in the shadows, the stock markets have lost the fuel to keep them charging higher since 2009.
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