While the mainstream media is quick to blame the woes of North American stock markets on the crisis in Greece and the collapsing Chinese stock market, the fact is that American stocks were in a rout long before this.
I’m not tooting my own horn; but I’m sure you saw the video I produced late last year titled, “The Great Stock Market Crash of 2015.” In it, I gave six reasons why North American stock markets were doomed this year. Or maybe you saw my Outlook 2015 video where I predicted that 2015 would be a down year for stocks (that video is still up on YouTube, you can see it here.)
The bottom line; the easy monetary policies of the Federal Reserve created a stock market bubble. That bubble is now deflating.
For the first time since 2010, in the first six months of this year, stocks were flat. The table below plots the return of the S&P 500 in the first six months of each year since 2009.
S&P 500 Performance; First Six Months of Years Listed
Looking at big-cap stocks, the situation is worse. In the first six months of 2015, the Dow Jones Industrial Average lost 1.1%.
Stock Market Returns to Disappoint for Remainder of 2015
Over the past few years, investors and other market participants have become so irrational that they have overlooked basic economics. As I have written many times in these pages, for a stock market to go higher, the earnings and revenues of companies that trade in the market must rise.
But this isn’t happening with today’s stock market.
For the second quarter of 2015, earnings of S&P 500 companies are expected to decline by 4.5% year-over-year. If this actually happens, it will be the first decline in earnings since the third quarter of 2012 and the biggest since the third quarter of 2009! (Source: FactSet, June 26, 2015.)
Revenue at the S&P 500 companies declined in the first quarter of 2015. Sadly, it is expected to decline again in the second quarter. And it has been declining since the third quarter of 2009!
Unfortunately, this isn’t all.
Today’s investors have forgotten that stocks are impacted by the economy.
Over the last seven years, since the “recovery” in the U.S. economy began, economic growth in America has been dismal. However, stock prices have moved significantly higher—beyond the fundamentals that have historically supported stock prices.
Between 2010 and 2014, the U.S. economy has grown, on average, by two percent per year—well below the average of 3.4% since 1929. But the S&P 500 index has grown, on average, 13% each year—well above the historical average of eight percent since 1970.
Right now, the U.S. economy is in contraction mode. U.S. gross domestic product (GDP) declined in the first quarter of 2015. Early indicators are of the second quarter looking weak, too. Another negative quarter of GDP, and yes, we’re in recession again.
What I Learned From the Past
Over my years of investing, there are many things I have learned. But the most important is that markets trade on fear and greed—not fundamentals. Stocks always regress to the mean, but there is a lot of “noise” on that path back to what things are really worth.
For example, back in 2007, when key stock indices were forming a top, if you told anyone to move away from stocks, you were ridiculed. I know I was. But eventually, like always, the stock market reflected the earnings of the companies that trade in them and the economic conditions of the time.
Turning to today’s stock market, as I have been writing all year, it’s not worth buying into. It’s an overcrowded trade. Stocks have been overpriced and overvalued for a long time. We need a good, strong correction to make stock prices attractive again. And we may just get that correction this year. So, preserve capital.