If things weren’t bad enough for the stock market here in 2016, the Brexit could bring down the S&P 500 by 40%.
Even before the Brexit, U.S. corporate earnings were outright collapsing. S&P 500 earnings have been declining for four consecutive quarters—since the second quarter of 2015.
And corporate earnings of S&P 500 companies are expected to decline in the second quarter of 2016 as well—by more than five percent! The Brexit vote outcome is resulting in a major rally in the U.S. dollar as investors flock to safety. With half the S&P 500 companies deriving revenue from outside of the U.S., a higher-valued greenback will hurt sales.
If we take away the massive stock buyback programs Wall Street has been conducting, the picture gets really ugly.
In the first quarter of 2016, companies on the S&P 500 purchased $161.4 billion worth of their own shares—this was the second-largest amount on record! The buybacks were 12% higher than the first quarter of 2015.
For the trailing 12 months (ending on March 31, 2016), S&P 500 companies have spent $589.4 billion on buybacks! (Source: “S&P 500 Firms Spent $161.4 Billion on Share Buybacks in the First Quarter,” The Wall Street Journal, June 2016.)
When a company buys back its own shares, it’s reducing its share count. This essentially makes the company’s earnings look better. It’s called financial engineering and it’s legal.
Brexit Fear Crashing S&P 500
The odds of a major stock market crash for Wall Street in 2016 remain very high. The last thing you want to do is get stuck in the middle when stocks are falling and lose a significant amount of money. Remember: losses usually occur very quickly. Look what’s happening today, as the Brexit fear is punishing S&P 500 companies.
How far could the stock market crash? Please look at the long-term chart of the S&P 500 below.
Chart courtesy of www.StockCharts.com
Looking at the chart, one thing is very clear: the S&P 500 wasn’t able to break above the highs it made in early 2015 (the area marked by the black rectangle) as buyers are getting exhausted. This is very dangerous.
The S&P 500 could easily drop below the lower end of the range it has been trading in for the past 12 months. If we break below that range, the S&P 500 at 1,200 to 1,400 could become a reality—that’s roughly 42% from where it has been trading in April to June.
It’s a very risky stock market and investors should be cautious. The Brexit fear could just be the beginning of the catalyst that sends the S&P 500 down for the remainder of 2016.