As we enter the final month of the year, stocks (as measured by the S&P 500) have made little progress for the year. Unfortunately, many hedge and mutual funds are lagging well behind on a year-to-date basis which is putting pressure on them to chase performance.
With the Federal Reserve now set to tighten monetary policy for the first time in a decade, while every other country in the world is in a race to negative rates, the risk to investors has risen markedly. This is particularly the case given the downward pressures on economic growth from low oil prices, a surging dollar and weak consumption trends.
However, while the underpinnings of the market and economy have significantly deteriorated, it has not impacted the always optimistic views of Wall Street. Expectations for a continued bull market into the future remain firmly intact. As I stated earlier this week:
“Just this year there has been a rising number of articles suggesting that we have once again entered into a ‘Goldilocks Economy.’
The problem is that in the rush to come up with a ‘bullish thesis’ as to why stocks should continue to elevate in the future, they have forgotten the last time the U.S. entered into such a state of ‘economic bliss.’ You might remember this:
‘The Fed’s official forecast, an average of forecasts by Fed governors and the Fed’s district banks, essentially portrays a ‘Goldilocks’ economy that is neither too hot, with inflation, nor too cold, with rising unemployment.’ – WSJ Feb 15, 2007
Of course, it was just 10-months later that the U.S. entered into a recession followed by the worst financial crisis since the ‘Great Depression.'”
The problem of suggesting that we have once again evolved into a “Goldilocks economy” is that such an environment of slower growth is not conducive to supporting corporate profit growth at a level to justify high valuations.
Such a backdrop becomes particularly problematic when the Federal Reserve begins to raise interest rates which removes one of the fundamental underpinnings of an overvalued market which was low interest rates. Ultimately, higher interest rates, particularly in an economy with a deteriorating economic backdrop, becomes the pin that “pops the bubble.”
I only offer the suggestion that one should deeply consider the possibility that things could go wrong. While Janet Yellen is adamant the current backdrop is “prime” to lift interest rates, it should be remembered that Ben Bernanke did not understand the implications of the housing bubble and the ultimate economic backlash.
This weekend’s reading list contains a list of views on the outlooks for 2016, thoughts on the Federal Reserve, the economy and the markets.
Goldman Sachs – These 10 Themes Will Dominate World Markets In 2016
Merk Investments – 2016 Outlook For Markets, Gold & The Dollar
Goldman Sachs – Markets Will Go Nowhere In 2016
Kiplinger – Stocks To Return 8%
Societe Generale – 2016 Another Good Year For Equities, Worry Is In 2017
Convergex – 2016 Market Outlook Shakey
BMO Capital Markets – S&P Will Suffer First Calendar Loss Since 2008
Forbes – Why WallStreet Expects 7-11% Upside
RBS – 10 Key Points For 2016
JP Morgan – 10 Emerging Market Themes For 2016
Business Insider – Wall Street Compendium Of Outlooks For 2016
ON THE FED
The False Promise Of A Rules Based Fed by Greg Ip via WSJ
“Like advocates of the gold standard, proponents of the bill blame many of the economy’s ills on the Fed exercising too much discretion because it succumbs to economic expediency or political pressure. Many see the Fed’s emergency lending during the crisis and its bond-buying since then as bailouts for big, reckless banks and a profligate federal government. They want rules to circumscribe such discretion.
But history shows that discretion is unavoidable no matter what sort of standard a central bank uses.“
Markets Still Aren’t Ready For A Fed Hike by Jenny Cosgrave via CNBC
“Investors should not wait until FOMC to take profit. It is pretty clear that the Fed will deliver a dovish hike. Even if your inclination is hawkish, December 17 is not the time for a display of hawkish personality, given that what is now and likely to be priced on December 15 is a very flat path.“
The Fed Is Out Of Touch With Reality by John Mason via TheStreet
“How good has the Federal Reserve been at predicting how its policies will affect the behavior of the U.S. economy? Not that good.”
Fed Is Tightening To Pre-Empt What? by Paul Kasriel via Financial Sense
“I submit that this tightening will go down in annals of Fed history as one of the most preemptive, if not, the most preemptive. I say this because the December 16th tightening will occur as a U.S. economy, short of full employment, already is losing momentum with no discernible signs of inflationary pressures. Although this quarter-point increase in Fed policy interest rates will not have a significant negative effect on nominal aggregate demand growth, it will have a marginal negative effect.”
ON THE MARKETS
The Calm Before The Storm by Doug Kass via Kass’ Corner
“Economic news and corporate profits matter, and so does market breadth. Healthy bull markets have broad participation, but unhealthy ones have narrowing participation.
The best gauges of market breadth are the advance/decline line and the number of stocks hitting new 52-week highs.
Strong bull markets exhibit bold cumulative advance/decline lines and expanding 52-week highs, which confirm the highs reached in the broad indices (where large-capitalization stocks dominate). But weak bull markets show breadth that diverges from the big indices on these two measures, failing to confirm the new highs.”
Morgan Stanley Throws In The “Perma-Bull” Towel by Tyler Durden via ZeroHedge
“While our base case is for low-to-mid-single digit returns, we do think it is prudent to modify our bear outcome, given it was last set during the throws of the August sell-off. We are raising our bear case from 1500 to 1600, though we still feel the bear case embeds a mild recession in the US. In our bear case, earnings are down 2% this year, and 5% per year for 2016 and 2017. At the end of 2016, investors would pay just above 15x earnings for a view that earnings will be $105.2, yielding a bear case target of 1600. This is roughly 23% down from today’s levels.”
The Bull Market Rumbles Forward by Ken Fisher via Forbes
“The most stunning unnoted market phenomena right now are the parallels between the past eight years and the period between 1988 and 1997. History never repeats itself, but this rhymes. This bull cycle may last longer than anyone imagines–maybe the longest ever.”
ON THE ECONOMY
The Perils Of Economic Forecasts by Buttonwood via The Economist
“THE joke is not new but it is a good one. How do we know that economists have a sense of humour? They put decimal points in their forecasts.“
US Economy Resumes Contraction In November by Political Calculations
“According to Standard & Poor’s Monthly Dividend Action Report, the relative health of the private sector of the U.S. economy declined in November 2015, as the number of U.S. companies acting to cut their dividends during the month rose to 35 – a level that is consistent with previous periods of time in which the U.S. economy experienced outright contraction.”
Why You Shouldn’t Ignore Contracting ISM by Tomi Kilgore via MarketWatch
“A key gauge of manufacturing activity has double-dipped into recession territory, but stock market investors don’t seem to care. History suggests, however, that maybe they should.”
- 8 Depressing Stats About Retirement Savings by Michael Johnston via Fund Reference
- A Conversation With Cliff Asness by Tyler Cowen via Conversations With Tyler
- The Secret Stock Market Accounting Trick by John Crudele via NY Post
- The Worlds Most Dangerous Central Banker by David Stockman via Stockman’s Contra Corner
- Numbers AMZN Doesn’t Want You To See by Mark Hulbert via MarketWatch
- Era Of High Oil Prices At An End by Daniel Yergin via CNBC
- Did Something Blow Up In Junk? by Jeff Snider via Alhambra Partners
- Distress In Corporate Debt At 2009 Levels by Wolf Richter via Wolf Street
- Markets Are In Extreme Late Stage by John Hussman via Hussman Funds
“Everyone is a disciplined, long-term investor until the market goes down.” – Steve Forbes
Have a great weekend.
For daily commentary, follow me on Twitter