Why the Market is Whipsawing

By David B. Armstrong, CFA | Feb 16, 2016 | Weekly Market Commentary

The 2016 stock market sell-off has had the attention of everyone with investments and/or a TV. I never want to come off as flippant about losses, but it’s also important to have some perspective on the actual losses. HISTORICALLY, the sell-off in the S&P 500 Index has been relatively ordinary so far, down just under 9%.  Check out the numbers from this “George Costanza” article I wrote back in 2012 for U.S. News and World Report:

“Let’s look at how often this happens. Thanks to Ned Davis Research, I’ve recently learned that there have been 294 dips of 5 percent or more in the S&P 500 since 1928. Put differently, that’s about three or four times a year that an average investor can completely screw up and do something stupid (I’m using the mean here).

It gets better.

The S&P 500 has dipped over 10 percent exactly 94 times since 1928. That’s just a little over one time per year (again, mean). Fifteen percent dips happen every other year and 20 percent dips every three years or so.

That’s a lot of opportunity to screw up, and the DALBAR study proves that individual investors are taking full advantage of their opportunities. The sad part is that the study quotes a 3.49 percent return for the average investor. That means that there are investors doing WORSE than that. But it also means there are people doing better, too.”

There has been no shortage of reasons, cited by me, the press and everyone else, trying to explain the recent volatility and decline.

I wrote a more detailed list in my Special Report, but here is more narrowed list:

1. Last week, Fed Chief Janet Yellen offered up a cautious outlook to Congress.
2. While the freefall in oil prices seems primarily due to excess supply, it’s adding to worries that there is global economic slowdown.
3. Banks are getting crushed.
4. Chin-ugh (See what I did there? China and Ugh..) and the persistent worries about the Yuan.
5. Too much emerging market debt.
6. There are budding worries about European banks.

It’s natural in the news cycle to see anxiety ratchet up about non-U.S. issues overseas, especially over the short-term. BUT, I believe that one of the biggest long-term factors for stock prices is corporate profits.

Take a look at this chart below from Charles Sherry.

Note: Q4 2015 profits include 71% of firms which have reported Q4 earnings and estimates for the remaining 29%

What the chart is showing:

1. The green bars represent the actual change in profits at S&P 500 companies versus the prior year. Up until the second quarter of 2015, they were positive.
2. The blue bars represent the collective forecasts by analysts for S&P 500 profits issued on November 30, 2015 by Thomson Reuters.
3. The red bars represent the collective forecasts for S&P 500 profits issued on February 10, 2016.

What should jump out at you is that there is a sharp drop in expectations for Quarter 1 (Q1) and Q2 of 2016.

Take a look at Q1. You can see by the blue bar that the original forecast was set to rise 3.6% back in November. Take a look at the red bar which represents February Q1 earnings and you see that they are now expected to be negative, at 4.6%.

So much for the projected “about-face” in Q1 2016…which is now delayed until Q3.

So where do we point the fingers? Well, look no further than the steep downgrades in the Energy sector.

Here’s the downside: we may see four straight quarterly declines in S&P 500 profits. That’s taking a toll on investor sentiment.

I still believe that we will avoid a recession in the U.S., and as long as our economic growth remains tepid at worst, profit growth will probably resume later in the year. So there’s a positive for ya.

It’s going be a choppy year in the market…unless you need liquidity, don’t sell since you can’t guess when the market is going to turn around.

Please call with any questions.

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