A few weeks ago we wrote the following:
Our "base case" is that 2016 is likely to be marked by a higher level of volatility and overall lower average market returns than we have seen in recent years. We also feel the probabilities of currently unknown events shaping market behavior are higher than it has been in the past. Our underlying rationale for our "base case" has to do with two major themes: divergent monetary policy (The U.S. Fed raising rates while other central banks are still easing) and the China wildcard.
The S&P 500 and the Dow Jones Industrial Average just closed out their worst month since markets freaked out last August. The Nasdaq Composite had its worst month since May 2010.
The Dow was down 5.5% for the month.
Since January 1 the German DAX is down 8.8%, the Shanghai Composite is down 22.6%, the Japanese Nikkei is down 7.9%.
It was a very tough month for stockholders.
Clearly divergent monetary policy is influencing the market. The U.S. Fed tightened in December. The Bank of Japan eased today. That is what caused the Friday rally. But we are not confident it will be enough to continuing bolstering stocks.
China's economic growth rate is clearly slowing. It may be that the U.S. is slowing too. We are still not forecasting disaster or "hard-landings" for either economy. But we are monitoring the slowdown.
We also need to recognize that stocks were overvalued at the end of 2015. A correction was ripe to happen.
We need to understand that earnings growth is rapidly decelerating in many industries.
Some individual stocks have just been pummeled. One of my favorite companies is Textainer Corp (TGH). It is down over 23% in January. Even Amazon (AMZN) is down over 13%.
The rally today was huge, but could easily be part of a "bear market rally". We are not likely to know for sure for another few weeks.
Our current base case for U.S. equities is that the path of least resistance is likely to be lower. Rallies appear to be opportunities to sell stocks, raise cash, and/or short stocks.
The most likely outcome for the S&P 500 is a completion of this topping pattern which is called a "Head and Shoulders Top". If this pattern plays out this index will revisit its recent low in the 1860-1850 range. If that support does not hold this pattern suggests that the S&P 500 could eventually go as low as 1576-1604.
We shall see.
Disclosure and Disclaimer - Updated last on JANUARY 6, 2016 by Paul Krsek:
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