If you have been following my writings, you know my 2015 prediction was that stocks would fall during the year and that 2015 would be the year the stock market put in a major top. And that’s exactly what the market did. In fact, 2015 was the first year since 2008 that the Dow Jones Industrial Average ended the year lower than it started the year, falling 2.2%.
One of the most important factors that determine the direction of the stock market is the money flowing in or out of it. When you look at that today, it’s outright frightening. According to the Investment Company Institute, in the first 10 months of 2015, U.S. long-term stock mutual funds witnessed an outflow of $125 billion. Looking at the weekly data between November and mid-December, these mutual funds witnessed an outflow of another $43.0 billion. This amounts to more than $168 billion worth of outflows. (Source: Investment Company Institute, last accessed December 29, 2015.) In 2014, U.S. stock market mutual funds had outflows of only $60.0 billion in 2013; they actually had inflows of $18.0 billion.
Two Fundamentals Say Stock Market Crash Is Possible
Going into 2016, two things suggest a stock market crash is a real possibility. I’m talking about revenue and earnings at America’s public companies.
In the second and third quarter of 2015, corporate earnings of S&P 500 companies declined. In the fourth quarter, they are expected to decline again—this time by 4.9%. This will be the first time we will see corporate earnings decline for three consecutive quarters since 2009. (Source: FactSet, December 24, 2015.)
Revenue is all also contracting. Revenue at S&P 500 companies is expected to decline in the fourth quarter of 2015, marking four consecutive quarters that revenue for the S&P 500 companies has declined—the first time this has happened since the fourth quarter of 2008 through the third quarter of 2009.
If this wasn’t enough to convince you a stock market crash could occur in 2016, then look at the optimism among investors. Look at the chart below of the Wall Street Sentiment Survey; it tracks the opinion of experienced traders and analysts.
Seventy-five percent of all the respondents to the recent survey were bullish on the stock market. This is the highest percentage of traders and analysts bullish on the stock market since 2012. Before that, they were this bullish near the end of 2007 and late 2008, just prior to the previous stock market crash.
If history is something that we should learn from, then too much optimism has never worked well for the stock market. Over-optimism about stocks, like we have today, has been one of the best indicators of a stock market crash.
Stock Market Outlook for 2016
Again, going into 2016, I am very pessimistic about the stock market. The basic fundamentals are working against the S&P 500 (people are pulling money out of long-term stock mutual funds, earnings are contracting, revenue is contracting). And greed is too strong with so many traders and analysts bullish on the stock market at the same time (the market always delivers the opposite of what they expect). As for fear, it doesn’t exist right now. We are set up for a classic stock market crash in 2016.