Stocks plunge into negative territory for 2015 thanks to a very widespread sell-off last week. Crashing oil prices, a blow up in the high-yield bond industry, big currencies moves, and general uneasiness about if the Federal Reserve should raise rates in December all played a part in the market's sharp decline. It was the worst one-week drop since the August correction lower. Transportation stocks fell -5.4% last week. The semiconductor index lost -4.4%. Financial stocks plunged -6.2%. The S&P 500 index lost -3.8% and is now down -2.2% year to date. The small caps were hit hard with the Russell 2000 index crashing -5%.
Chinese Yuan Movement
China made headlines again when their government announced they would unpeg their currency, the yuan (also known as the renminbi), from the dollar. Now it will track against a basket of currencies. Many believe this step will set up for another devaluation. China shocked the market several months ago when they unexpectedly devalued their currency. The Forex market reacted by sending the yuan down -0.5% to a new four-year low of 6.45 yuan to the dollar. This move is fueling concerns that China is spreading deflation around an already economically weak global economy. If the Fed does raise rates soon it will strengthen the dollar and push the yuan even lower.
High Yield Bond Implosion
Another big story was Friday's headline that Third Avenue Asset Management had halted redemptions from their high-yield Third Avenue Focused Credit Fund. Worries over the safety of high-yield bonds had sparked a flood of investors trying to exit. The problem is that a lot of high-yield assets are extremely illiquid and have to be shopped around before getting sold. This can take weeks or months. Instead of selling their assets at whatever-they-can-get prices the fund decided to just halt redemptions and liquidate the fund. Being very illiquid it could take a year for Third Avenue to finish liquidating this fund's assets to avoid fire-sale prices.
The thought of being locked out and unable to redeem your money from a fund sparked a mild crisis on Friday among high-yield asset investors. As the old Wall Street saying goes, "there is never just one cockroach". That would suggest there are other high-yield funds in trouble. Sure enough, after the closing bell on Friday, Stone Lion Capital blocked redemptions from its credit hedge funds.
The iShares High Yield Corporate (credit) ETF (HYG) was hammered on Friday with a -2% plunge to lows not seen since July 2009. Odds are good it could see another big drop on Monday. The HYG lost -3.8% for the week and is down more than -11% for the year.
Chart of the HYG
Over the last several years there has been an interesting correlation between moves in high-yield assets and the broader stock market. Looking at the HYG etf since 2007 every time the HYG has a drop of -5% or more it's followed by a -9% plunge in the S&P 500 index. This has happened nine out of the last ten -5% declines in the HYG. This doesn't bode well for the stock market.
Another interesting factoid that might have broader implications for the market is the ballooning of high-yield debt. During the 2008 financial crisis there was about $700 billion in high-yield corporate debt. Today there is almost $1.8 trillion. The Federal Reserve's 0% interest rate policy generated huge investor demand for anything with a big yield. One industry that took advantage of this demand was energy. Now crude oil is crashing and it's going to generate some corporate bond defaults among energy companies.
Crude Oil Plunges
Crude oil was an anchor around the stock market's neck all week long. The commodity's sell-off accelerated lower last week with crude oil prices falling to six-year lows. Oil is down eight of the last nine weeks and ended Friday at $35.51 a barrel. WTI oil futures are now down -42% from its 52-week high of $61.43 a barrel.
Last Friday (Dec. 4th) was the final OPEC meeting of 2015 and the group did not adjust their quotas. Saudi Arabia manhandles the cartel and they are dictating a policy to grab market share on lower prices to try and force higher-cost producers out of business. Until lately the strategy really hasn't worked that well.
U.S. producers have become very adept at lowering their expenses and profitably produce oil in spite of lower prices. That appears to be changing. U.S. energy companies have been slashing capex budgets and dividends. Now we are seeing producers halt production, halt drilling, and lay off workers. The number of active oil and gas rigs has fallen to multi-year lows. That doesn't bode well for the high-yield debt market since so many smaller oil companies used high-yield debt to finance their operations. There is a growing expectation that the lower crude oil prices fall the bigger the defaults we are going to see in the energy industry. Crude oil lost -11.6% last week. Oil stocks fell -7.2%. Oil service stocks lost -5.9%.
We had a number of economic reports last week. The Producer Price Index (PPI), a wholesale gauge of inflation, rose +0.3%. The core PPI, which excludes more volatile food and energy prices, also rose +0.3%. That's good news since we want to avoid deflation. The prior three months had been negative.
The U.S. retail sales figure for November came in below expectations. Economists were forecasting +0.3% but the headline number was just +0.2%. Excluding automobiles and gasoline sales, the retail sales for November rose a healthier +0.6%. While the headline number was below estimates it's still improvement after three months of virtually zero gains for retail sales.
The University of Michigan Consumer Sentiment index preliminary reading for December showed some improvement with a small jump to 91.8. November's final reading was 91. Gasoline's drop toward seven-year lows probably helped boost consumer sentiment.
Put them altogether and the Atlanta Federal Reserve beliefs the outlook for Q4 GDP has improved. They adjusted their GDPNow estimate from +1.5% to +1.9%.
Chart of the Atlanta Fed GDPNow Estimate
Overseas Economic Data
The Swiss National Bank left their main interest rate unchanged at -0.75% (yes, that's negative 0.75%). Meanwhile the Bank of England left their interest rate unchanged at 0.5%. The BoE also left their QE program unchanged at 375 billion pounds. Neither decision was a surprise for the market.
Germany said their consumer price index (CPI) for November improved +0.1% from October. Italy reported that their industrial production for October rose +0.5% for the month and up +2.9% from a year ago. France announced that their industrial production for October also rose +0.5%. Meanwhile French CPI fell -0.2%, which was lower than expected. The Eurozone announced that Q3 GDP rose +0.3% from the prior quarter. It's up +1.6% from a year ago, which was in-line with estimates.
Japan said their large manufacturing conditions for the fourth quarter retreated from 11.0 to 3.8. Analysts had been expected a rise. Japan also announced that their core machinery orders for October rose +10.7% for the month. That was significantly better than expected. The country's Q3 GDP estimate was revised higher from -0.1% to +0.3% versus the prior quarter.
China made headlines on Tuesday when their November trade surplus contracted. Economists were expecting a rise from October's $61.6 billion to $63.3 billion. Instead their surplus dropped to $54.1 billion. Chinese exports fell -6.8% as imports dropped -8.7%. This slowdown doesn't bode well for global growth expectations.
Fortunately the latest estimate on Chinese GDP seems to be improving. A lot of analysts view the official Chinese GDP estimate with skepticism. Bloomberg produces their own estimate on Chinese GDP. Their most recent reading showed an improvement with Bloomberg's China GDP estimate rising to 6.85% in November, hitting a five-month high. This would suggest that China's stimulus efforts are working. According to Bloomberg analysts, if the slowdown in China has stabilized then it will provide support for the U.S. Federal Reserve's decision to raise rates.
There is no way to sugar coat it. Last week was ugly. The S&P 500 index plunged -3.8% with most of that on Friday's -1.9% decline. That pushes the index to a -2.2% decline for the year. The S&P 500 has sliced through short-term support in the 2,040 and 2,020 areas. It might bounce at 2,000, which would be round-number, psychological support, but I wouldn't bet on it. Market legend Art Cashin, with UBS Financial Services, said that when the S&P 500 loses more than -1.5% on Friday and closes near its lows for the session, the following Monday tends to be down. Odds are rising that we could see the S&P 500 spike down toward the 1,990 area before seeing an oversold bounce.
Daily chart of the S&P 500 index:
The NASDAQ composite lost -4.0% for the week. That shaved its 2015 gain to +4.1%. Friday's decline (-2.2%) crashed through what should have been support at 5,000 and its 50-dma and 200-dma. The daily chart would suggest there is support near the 4,900 level. If the 4,900 level breaks then the next area of potential support is 4,800.
chart of the NASDAQ Composite index:
Small cap stocks were crushed last week. The Russell 2000 index ($RUT) plunged -5.0%. It is now down -6.7% for the year. The breakdown below support at 1,140 is bad news. This index is down about 80 points from its December high. You could argue it's oversold and due for a bounce but it could always get more oversold before rebounding.
The next support area should be the 1,100 area and then the September lows near 1,080 below that.
chart of the Russell 2000 index
Economic Data & Event Calendar
This is it! It's the final FOMC meeting of the year. The Fed will hold a two-day meeting where it will likely raise interest rates on Wednesday. Everything else on the calendar will be overshadowed by this event.
We will see two regional Fed surveys (New York and Philadelphia). The Bank of Japan will announce its decision on interest rates although no change is expected.
The Republican presidential debate on Tuesday night could be entertaining as the candidates try and take down current front runner Donald Trump.
Friday will herald a world record as Disney launches their first Star Wars film after purchasing the franchise from George Lucas. "The Force Awakens" (episode 7) is expected to do more than $220 million in box office sales throughout the weekend, which would be the best opening for any movie in history.
- Monday, December 14 -
- Tuesday, December 15 -
Germany's ZEW index
Consumer Price Index (CPI)
New York Empire State manufacturing survey
NAHB Housing Market Index
FOMC two-day meeting begins
U.S. Presidential Debate for Republican candidates
- Wednesday, December 16 -
Eurozone PMI data
Building Permits and Housing Starts
FOMC meeting, interest rate decision, new forecast
Fed Chairman Yellen's press conference
- Thursday, December 17 -
EU leaders begin two-day summit in Brussels
Bank of Japan interest rate decision
Philadelphia Fed survey
Russian President Vladimir Putin holds annual news conference
- Friday, December 18 -
EU two-day summit (ends)
Federal Reserve Bank of Richmond President Jeffrey Lacker will give his 2016 U.S. economic forecast
Disney's "Star Wars: The Force Awakens" hits theaters
Additional dates to be aware of:
Dec. 24th - Christmas Eve (market closes early)
Dec. 25th - Christmas (market closed)
Jan. 1st - New Year's Day (market closed)
As we look at the week ahead the market will be focused on one thing and that is the FOMC meeting. According to Bloomberg, the fed funds futures indicate an 80 percent chance that the Federal Reserve will raise rates on Wednesday. It will be the first rate hike since 2006. The Fed has kept rates near zero (0.0%-0.25%) since 2008. Analysts are expecting the Fed to raise rates into the 0.25-0.5% range.
There is a chance that the Fed will not raise rates. A lot of the U.S. economic data over the last few weeks is suggesting the economy is slowing down. That's not an environment the Fed wants to raise rates. The plunge in oil prices and commodities in general is another reason the Fed may want to postpone raising rates. If they do the dollar will strength and commodities will fall even further. This is deflationary.
A few days ago Jeffrey Gundlach, who runs the $51 billion Doubleline Total Return Bond Fund, which has outperformed nearly all of its peers, expressed serious doubts about the Fed raising rates this week. Bloomberg published an interview with Gundlach where he noted that the U.S. economy is fragile and the credit markets are collapsing (referring to the junk-bond market). Gundlach also expressed concern about U.S. manufacturing currently in a recession and corporate profits have mostly stalled. It's not a good environment to be raising rates.
There are also analysts who believe the Fed must raise rates to maintain their credibility after delaying the move for so long.
Historically whenever the Federal Reserve begins a tightening cycle (raising rates) the stock market tends to sink and valuations retreat.
Dark Side To Merger Mania
Thus far 2015 has been a huge year for M&A activity.
Earlier this month Keurig Green Mountain, the company that makes the K-cup coffee machines, agreed to be bought out for $13.9 billion. This pushed the value of all deals this year to a record-setting $4.614 trillion. There have been over 18,600 deals worldwide this year. The last time we saw this much M&A activity was 2006-2007. Before that there was a peak in M&A deals in the 1999-2000 time frame. Do you notice anything funny about those dates? These peaks in merger and acquisition activity occurred just ahead of major market declines and economic recessions.
Banking giants Citigroup and JP Morgan Chase are both forecasting a 65% chance of a recession in the next several months. Andrew Sorkin recently wrote in the New York Times that the surge in M&A follows this pattern of pre-recession spikes. Here's more on the story from the OptionInvestor market wrap, "The theory was that revenue growth was slowing, cost cutting had run its course and the only avenue left for corporations to continue to grow was to merge with someone to gain access to their customers and product lines and reduce costs even further through synergies. Sorkin quoted a Citigroup study with the same conclusions. This further suggests a recession is headed our way over the next 12-18 months."
You can read more about it here:
Why the Great Merger Frenzy of 2015 signals another recession
The M&A story forecasting a recession is definitely troubling but that is not going to pressure the market lower in the week ahead. On a short-term basis stocks are oversold. We should see a bounce. However, the market's major indices closed near their session lows on Friday. That would normally suggest a decline for Monday morning.
Investors normally buy the mid-December stock market pullback in anticipation of the traditional Santa Claus rally into yearend. Yet the S&P 500's breakdown below its mid-November lows is technically bearish. It now has a new lower low in place. If you're feeling optimistic then the index could be building a big bull-flag consolidation pattern and it's currently near the bottom of its trading range. That might just be wishful thinking on my part.
With the FOMC meeting on Wednesday it wouldn't surprise me to see a drop on Monday morning and then see stocks churn sideways until the Fed's announcement on Wednesday. The question is whether or not stocks will rally or sell-off on the Fed's decision. If the Fed raises rates then you could argue they're doing it at the wrong time and endangering the U.S. and global economy or if they raise rates it's a vote of confidence in the strength of the economy. If they do not raise rates then you could argue they are worried about the U.S. economy and do not think it's strong enough to endure a rate hike. Either way it could be another excuse to sell stocks. Then again bull markets usually climb the wall of worry. I would not be in a rush to launch new bullish positions. This might be a good week to stand back and watch the fireworks.