The stock market is becoming a dangerous place to be. Going into the New Year, my stock market forecast for 2016 is negative on the S&P 500 for the three reasons I outline below.
Corporate Earnings and Revenues Are Contracting at an Accelerated Pace
Rising corporate earnings and revenues are the two most basic factors that drive the stock market higher. Remember back in 2008? As corporate earnings and revenues fell, the biggest stock market crash since 1929 occurred.
Today, corporate earnings and revenues are falling again.
In the third quarter of 2015, corporate earnings of S&P 500 companies declined by about two percent after dropping 0.7% in the second quarter. (Source: FactSet, November 13, 2015). And there’s more bad news: corporate earnings for the S&P 500 are expected to decline another 3.6% this quarter!
Revenue figures are horrible, too. In the second quarter of this year, the revenues of S&P 500 companies declined by 3.4%. In the third quarter, revenues for the S&P 500 companies dropped by an even four percent. In the fourth quarter, they are expected to decrease by another 3.1%. If the estimate holds and the fourth quarter is negative for corporate revenue, it will be the first time revenues have declined for four consecutive quarters since the fourth quarter of 2008 through to the third quarter of 2009!
Stock Market Valuations: Highest in Five Years
Sadly, investors aren’t paying attention to the stock market fundamentals whatsoever. Please look at the chart below of the price-to-earnings ratio of the S&P 500. This chart essentially tells us how much investors are willing to pay for every one dollar of earnings.
Chart courtesy of www.StockCharts.com
As it stands, investors are willing to pay close to $22.00 for every dollar of earnings on the S&P 500. This is the highest amount paid by investors since late 2010!
Stock Market Forecast for 2016
The stock market has been able to stay at high levels due to share buybacks and low interest rates.
This could all change in 2016.
The Federal Reserve is talking about raising interest rates as soon as this December. Rising interest rates have never been good for the stock market, as corporate America experiences higher interest costs.
As for stock buybacks, with interest rates at record-lows, S&P 500 companies were able to borrow money cheap and use the proceeds to buy back their shares. This not only made their per-share earnings look better, but it also boosted stock prices and, ultimately, the stock market. I see this as nothing more than financial engineering.
In 2015, the stock market used most of the year putting in a major top. Going into 2016, with stock valuations at record-highs, while corporate earnings and revenues are contracting, I am very pessimistic toward the stock market.