For a number of years now, I’ve maintained that the U.S. and global economies would be in better shape had the central banks from around the world never intervened. After eight years of manipulating interest rates and pouring trillions of dollars into the economy, with no exit plan I might add, stocks are getting their due. In the first three weeks of 2016, the global stock market crash has wiped out $15.0 trillion of investor wealth. That’s more than the global central banks poured into the economy to get it going.
And the downturn is just getting warmed up!
Quantitative Easing: A Failed Experiment
In an attempt to kick-start the economy, the U.S. Federal Reserve implemented its first round of quantitative easing way back in November 2008. At the time, the U.S. economy was being thrashed by the financial crisis and the bursting of the housing bubble. At the time, the U.S. unemployment rate stood at just 6.8%; less than a year later, it was at 10%. (Source: “Labor Force Statistics,” The Bureau of Labor Statistics, last accessed January 21, 2016.)
Artificially low interest rates were supposed to spur banks to lend money and grease up the economy. It didn’t really happen. When it came to consumers, all the banks really did was tighten their lending rules.
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After the Federal Reserve successfully sucked “income” out of fixed incomes, Americans who once had dreams of retiring, had to wake up to a new reality. The only place to make money was the stock market.
And so they did. Investors poured into the stock market, pushing it higher and higher. Between March 2009 and when the markets bottomed and May 2015, when it hit a new high, the S&P 500 climbed roughly 200%. Over the same timeframe, the Dow Jones Industrial Average advanced nearly 185%.
By the time QE ended in October 2014, the Federal Reserve had purchased $3.5 trillion in bonds. Stocks were in the triple digits and unemployment was down to 5.7%. To quote a popular phrase, “Mission Accomplished!”
Except it wasn’t. The stock market gains were built on shadows and fog.
Stock Market Crash Is a Warning Sign
The coming stock market crash can’t be a total surprise.
Like a broken record, I will reiterate, in 2013, the year that saw the S&P 500 soar 30%, S&P 500 consistently revised their guidance lower, quarter after quarter. In the fourth quarter of 2013, a record 88% of S&P 500 companies revised their earnings guidance lower.
In effect, investors, with nowhere else to go, rewarded S&P 500 companies with higher share prices for poor performances. Eventually, share prices have to catch up with reality.
What went on in 2015? The S&P 500, after years of double-digit gains, finished the year down -0.7%. While many were surprised to see the small dip, I have to wonder why the loss wasn’t greater.
In the fourth quarter, the estimated earnings decline is forecast at -5.3%. At the end of the third quarter, the forecasted earnings decline for the fourth quarter was just -0.6%. If the index reports a decline in fourth-quarter earnings, it will be the first time the index has reported 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 S&P 500 has seen four consecutive quarters of year-over-year revenue declines since the fourth quarter of 2008 through the third quarter of 2009.
And now stocks are wildly overvalued. The CAPE PE ratio for the S&P 500 is sitting at 24. That means that for every $1.00 of earnings, investors are willing to pay $24.00. The only time the index has really been higher was in 1929 and 1999. Compared to the historical average of 16.59, the S&P 500 is overvalued by roughly 69%. (Source: Yale University web site, last accessed January 21, 2016.)
The market cap to GDP ratio also suggests the S&P 500 is overvalued. A reading of 100% suggests the markets are fairly valued. The indicator is currently at 107.6% and is projected to return just 1.8% this year. While the ratio is down almost 12.0% since the beginning of the year, it’s still only been higher twice since 1950: in 1999 and at the end of 2015. (Source: “Market Cap to GDP,” Advisor Perspectives web site, last accessed January 21, 2016.)
A Global Bear Market
The fact of the matter is that U.S. stocks aren’t doing all that well and the global economy is doing much, much worse. Where does that leave investors? Swimming with the bears and the U.S. is getting its toes wet.
A bear market is typically defined as a 20% decline from its 52-week high. The U.S. markets aren’t there just yet. The S&P 500 is down 12% since hitting a high in May 2015. More strikingly, since the beginning of 2016, it has fallen 7.5%.
The resource and energy-heavy Toronto Stock Exchange is down 25% since hitting a high in May of 2015 and it’s down almost seven percent since the beginning of 2016. Lots of other stock markets are in trouble: China, Germany, Japan, England, and France—bear, bear, bear, bear, and bear.
The MSCI World equity index has fallen 11% in January and is at its lowest level since October 2012. If this level is sustained, it will be the worst monthly loss since October 2008, the month after Lehman Brothers went bankrupt.
Is America’s economic collapse far behind?
Since the beginning of the year, $15.0 trillion has been wiped out from global equities—more than all the Federal Reserve and all central banks have printed off since 2008 to kickstart the economy.
Emerging economies are not really emerging right now either. The MSCI Emerging Markets Index is down seven percent since the beginning of the year and is at its lowest level since July 2009. It’s also down 34% since hitting a 52% week high in April 2015.
And there’s not much going for the global markets in 2016. The World Bank forecast global gross domestic product (GDP) in 2015 to be just 2.9%. That’s down from previous guidance of 3.4%. It also predicts U.S. GDP will grow just 2.5% in 2016, while European GDP will be an anemic 1.7%, and Japan’s GDP is a blip at 1.3%. (Source: “Anemic recovery in emerging markets to weigh heavily on global growth in 2016,” World Bank, January 6, 2016.)
More Downside to Come
Until the global economy rebounds, the U.S. and global markets will remain volatile.
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