Wall Street opens after the Dow suffered its second-worst points drop ever. It closed more than 1,000 points lower Thursday. The worst drop in history, nearly 1,200 points, happened Monday. I join CBS This Morning to discuss why the market is in correction territory.
With two weeks to go, it’s time to look back and reflect on what stories shaped the year. In chronological order, here are my “6 Biggest Money Stories of 2016”. 1. US Stock Market Correction: Investors were plunged into reality in February, as fears of a global growth slowdown pushed US stock indexes into a correction, which is defined as a more than 10 percent drop from the previous high mark. While stocks grabbed the headlines, it was the action in crude oil that freaked out insiders. On February 11th, US crude closed at $26.21 per barrel, the lowest point since 2003 and a 75 percent plunge from the June 2014 peak. The combination of weakening demand and fears of a global oil glut, prompted the International Energy Agency to say, "With the market already awash in oil, it is very hard to see how oil prices can rise significantly in the short term."
2. Fed Inaction/Action: A year ago, the Federal Reserve did something it had not done in nine years: it raised short-term interest rates by a quarter of a percentage point. The action ended a near seven-year period of zero interest rate policy or “ZIRP”. At that same December 2015 policy meeting, officials also released their “dot plot,” which is where each Fed meeting participant anonymously provides a prediction of where the fed funds rate should be at the end of the year for the next few years and in the longer run. The median forecast was for rates to rise by full percentage point in 2016, which we now know, was way off. Whether it was worries about slowing growth, the UK vote on whether or not to leave the European Union or the US Presidential election, it was the Fed’s inaction in 2016, which shaped most of the year. Now with the Fed’s one rate hike of 2016 behind us, the big question is whether the central bankers’ new dot plot, which anticipates a 0.75 percent in additional rate increases in 2017, comes to fruition or not.
3. Brexit: It may now seem quaint to remember what a big surprise it was that UK voters decided to leave the European Union on June 23rd. “Brexit” was a seismic and unexpected result, which caught global investors off guard. Markets tumbled in the days after the vote, but recovered fairly quickly. The vote forced Prime Minister David Cameron to step down and propelled Theresa May, who half-heartedly supported the Remain camp, to succeed him. May has vowed to begin the process of leaving the EU by the end of Q1 2017.
4. Wells Fargo Sales Debacle: When news emerged that Wells Fargo employees’ fraudulently opened as many as two million deposit and credit-card accounts without customers’ knowledge, in order to hit internal sales targets, it was a scandal that seemed impossibly old school. As Time’s Rana Foroohar noted, “the fraud in this case was just so easy for average people to understand.” What was harder to figure out was the bank’s response to the fraud. Instead of admitting that management had created a culture, which encouraged cross-selling at any cost, it cut 5,300 bad apples, paid a $185 million fine to regulators and hoped to sweep the whole issue under the rug.
Not so fast...the public outrage, combined with a Congressional hearing where Senator Elizabeth Warren took the unusual step of telling then-CEO John Stumpf to resign (“Have you fired any senior management, the people who actually oversaw this fraud... Your definition of accountability is to push this on your low-level employees. This is gutless leadership.”) Weeks later, Stumpf stepped down.
5. Wage Gains: If 2014 and 2015 were the strongest years of job gains of the recovery (+260K/mo and +221/mo, respectively), 2016 was the year when wages finally accelerated. Wage growth had remained stubbornly at 2 percent during the past few years, but in 2016, the improving economy and labor market helped wage growth start to outpace inflation. In November, wages were up 2.5 percent from a year ago. With the unemployment rate at nine-year lows, there is hope that the trend will continue -- and accelerate -- in 2017.
6. Post-Election Stock Rally/Bond Plunge: The much-feared market collapse that was associated with a Trump victory occurred…for about three hours on election night. But ever since president-elect Trump’s speech in the wee hours after the results were in, stock markets have gone parabolic on the upside. Worries about trade wars were replaced with delight over potential infrastructure spending, tax cuts and a reduction of regulations across a wide swath of industries.
While stocks were flying, bonds were plunging, as investors viewed those same policies as increasing growth rates and potentially spurring inflation. As a result, they believe the Fed will have to raise rates more quickly next year. Because higher interest rates erode the value of outstanding bonds, the price of 10-year treasuries have fallen and yields have jumped from a low of just under 1.4 percent during the summer to 2.6 percent, the highest level since September 2014.
- DJIA: 19,843, up 0.4% on week, up 13.9% YTD
- S&P 500: 2258, down 0.1% on week, up 10.5% YTD
- NASDAQ: 5437, down 0.1% on week, up 8.6% YTD
- Russell 2000: 1364, down 1.7% on week, up 20.1% YTD
- 10-Year Treasury yield: 2.59% (from 2.47% week ago)
- January Crude: $52.03, up 0.3% on week
- February Gold: $1,136.80, 6th straight weekly decline
- AAA Nat'l avg. for gallon of reg. gas: $2.23 (from $2.20 wk ago, $2.00 a year ago)
THE WEEK AHEAD:
Fed Chair Janet Yellen gives a speech on the state of the job market
10:00 Existing Home Sales
8:30 Durable Goods Orders
8:30 GDP (3rd estimate, previous=3.2%)
8:30 Chicago Fed Activity Index
8:30 Corporate Profits
9:00 FHFA House Price Index
10:00 Personal Income and Spending
10:00 New Home Sales
10:00 Consumer Sentiment
2:00 The U.S. bond market closes early ahead of Christmas
There were ostensibly three factors behind the recent stock market correction: (1) fear of a slow down in China, which can’t be stopped regardless of measures out of Beijing; (2) a sell off in commodities, which is pressuring emerging markets; and (3) continued concern about when the Federal Reserve will increase interest rates and how the lift off will impact asset prices. After two weeks of volatility, I am more convinced that the Fed may have had a larger role in the correction than the other two factors. Many look back to last Monday (aka “Black Monday” in China, where the main stock market index plunged 8.5 percent) as the beginning of the brutal downside action. Despite reports that Chinese government intervention was coming; there was none that day. All of the sudden, there was talk about the spread of contagion from a collapse in the Chinese stock market, to the Chinese economy, to emerging market economies and then to developed economies.
Let’s peel back the onion on this theory. According to Capital Economics, “The debacle in China’s equity market tells us little directly about what is going on in China’s economy.” The reason is that the massive bull market bubble, which began in 2014 and peaked on June 12th, “was speculative, rather than driven by any improvement in fundamentals…we are witnessing the inevitable implosion of an equity market bubble.” Since the top, the bears have wiped out $4.5 trillion of Chinese stock market value. Despite the massacre, the Shanghai Index is up 1.4 percent this year and a staggering 48 percent from a year ago.
Fear of a hard economic landing in China has been floating around for some time. In the big picture, the days of China’s double-digit growth rates are behind it. But because the total Chinese economy has increased in size, it continues to contribute more than a third of global growth. That’s why a slow down in growth from the government’s 7 percent target, to something closer to 5 percent this year, will reduce Chinese demand for a host of commodities, hence the rout in oil, industrial metals and emerging market trading partners who export those items to China.
And for those who were banking on the Chinese government to shield them from the effects of a slowdown, one hedge fund manager told me, “Too many investors believe that officials in Beijing know what they are doing. In fact, China is really in the minor league when it comes to economic management. Think of the U.S. as any big major league franchise, like the Yankees, the Giants or the Cardinals…China is like the Toledo Mud Hens-lots of great potential, but not in the show just yet.”
Of course all policy makers make mistakes (see: ECB), so maybe the take away is that when central bankers get nervous, we should all get nervous. And that leads us to what could have been the most important factor in the recent sell-off: the U.S. Federal Reserve. Yes, the impact of China and falling commodities is important, but some believe that that the selling pressure began on the Wednesday before Black Monday. That’s when minutes from the last Federal Reserve meeting were released. The officials’ views on current conditions painted a picture not of an economy rebounding strongly after a tough, weather-related first quarter, but of one that still faces downside risk, including “persistent weakness in the housing sector”. That comment prompted a lot of chatter because the data seem to indicate that housing is gaining a lot of momentum.
All of the sudden, it appeared that the Fed was not entirely sure what was going on and how it would respond to global events – that uncertainty sent shivers across trading floors. The stock drop only ceased after New York Federal Reserve President Bill Dudley, said that turbulence in the financial markets made a September rate hike “less compelling” than it was a few weeks ago.
With an economy growing at a better than three percent annualized pace, a labor market creating more than 200,000 positions per month, consumers and businesses spending more freely and a housing market finally making inroads, the best justification the central bank has for keeping rates at emergency levels is that there is little evidence of inflation. Still, it is hard to justify treating the U.S. economy like it is still in the intensive care unit. At some point, the central bank is going to have to normalize policy and when it does, nobody really knows how financial markets will react.
MARKETS: With one trading day left in August, stocks are on track for their worst monthly performance in three years.
- DJIA: 16,643 up 1.1% on week, down 6.6% YTD
- S&P 500: 1,988 up 0.9% on week, down 3.4% YTD
- NASDAQ: 4,828 up 2.6% on week, up 1.9 YTD
- Russell 2000: 1163, up 0.5% on week, down 3.5% YTD
- 10-Year Treasury yield: 2.19% (from 2.05% a week ago)
- October Crude: $45.22, up 11.8% on week
- December Gold: $1,134, down 2.2% on week
- AAA Nat'l avg. for gallon of reg. gas: $2.49 (from $2.61 wk ago, $3.44 a year ago)
THE WEEK AHEAD: It will be a busy, pre-holiday week on the economic calendar, highlighted by the August employment report. It is expected that the economy created 225,000 jobs and the unemployment rate should edge down to 5.2 percent.
9:45 Chicago PMI
10:30 Dallas Fed Mfg Survey
Motor Vehicle Sales
9:45 PMI Manufacturing Index
10:00 ISM Mfg Index
10:00 Construction Spending
8:15 ADP Employment Report
8:30 Productivity and Costs
10:00 Factory Orders
2:00 Fed Beige Book
Thurs 9/3: 9:45 PMI Services Index
10:00 ISM Non-Mfg Index
8:30 August Jobs Report
“Why did the market drop?” asked the radio anchor, after the market’s nasty drubbing on Thursday. My response was simple, “There were more sellers than buyers.” Sometimes, there is no particular reason for a sell-off. Sure, financial talking heads love to gin up explanations, but at the end of a rough session, sometimes simplicity works. For the past six weeks, a slow wave of selling has hit the once high-flying sectors of the market, pushing many components of the NASDAQ into a bear market (a drop of more than 20 percent from the recent peak). The NASDAQ Biotech index (NBI) is down 21.1 percent from its February 25th closing high; the Global X Social Media ETF (SOCL) has dropped 21.5 percent from the March 6th closing level; and the NASDAQ Internet index (QNET) is not quite in bear market territory (down 16.8 percent from March 6th), but its close enough that you get the point.
Meanwhile, the NASDAQ and the Russell 2000 are flirting with corrections (a drop of more than 10 percent), down 8.2 and 8 percent respectively since their early March highs. The broader S&P 500 is down just 4 percent from its all-time closing high reached on April 2nd. The big question is whether the selling represents the start of another technology-led total market meltdown? It’s not clear yet, but a review of the numbers is helpful to determine where markets stand.
The stocks that have seen the steepest declines also enjoyed the biggest run-ups. For example, prior to its recent sell-off, the Biotech Index saw an 87 percent gain over the prior 12 months. Even with the 21 percent sell-off, the index is still UP by 35 percent from a year ago. Of course that doesn’t mean that the selling will abate, which is why many are looking for clues from 14 years ago, when the dot-com bubble imploded.
In 2000, investors were coming off a long expansionary economic period and a huge bull market, which had driven up the valuations of stocks. According to Birinyi Associates, the S&P 500 was trading at 29 times its component companies' earnings for the prior 12 months. Today, The S&P 500 trades at 17 times earnings, slightly above average but well below those 2000 levels. The highflying sectors are indeed stretched, but not nearly as much as they were in 2000. The S&P 500 biotech index trades at 29 times component companies' earnings, which is above its median of 26 but far below the level of 57 at which it traded in 2000.
What appears to be happening is that investors are wising up a bit: taking their profits from the stocks that churned out big gains over the past year, paying their due to Uncle Sam and then rotating the proceeds into more value-oriented large stocks. In a world where emotions often rule the day-by-day action, that process seems positively rational.
- DJIA: 16,026, down 2.4% on week, down 3.3% YTD
- S&P 500: 1815, down 2.7% on week, down 1.8% YTD
- NASDAQ: 3999, down 3.1% on week, down 4.2% YTD (biggest weekly percentage loss since the week ending June 1, 2012)
- 10-Year Treasury yield: 2.63% (from 2.73% a week ago)
- May Crude Oil: $103.33, up 2.3% on week
- June Gold: $1318.10, up 1.2% on week
- AAA Nat'l average price for gallon of regular Gas: $3.63 (from $3.56 a year ago)
THE WEEK AHEAD: Earnings season kicks off in earnest, with low expectations for S&P 500 company earnings. Profits are expected to drop by 1.2% from the same quarter a year ago, according to FactSet Research, which would be the first contraction since the third quarter of 2012, though Thomson Reuters is slightly more optimistic, projecting growth of 1.1%. Revenue is seen rising only 2.3%.
American Airlines, Citigroup
8:30 Retail Sales
10:00 Business Inventories
Tues 4/15: TAX FILING DEADLINE!
Charles Schwab, Intel, JNJ, Coca Cola, Yahoo
8:30 Empire State Manufacturing
10:00 Housing Market Index
Abbott, American Express, Bank of America, Capital One, Google, IBM
8:30 Housing Starts
9:15 Industrial Production
2:00 Fed Beige Book
Janet Yellen to speak at Economic Club of NY
Blackrock, DuPont, General Electric, Goldman Sachs, Morgan Stanley, Pepsi
8:30 Weekly Jobless Claims
10:00 Philly Fed Survey
Fri 4/18: US MARKETS CLOSED IN HONOR OF GOOD FRIDAY
(Markets also closed in Australia, Brazil, Canada, Hong Kong, Singapore, and the UK)