Since the close on January 22, 2014, the SPDR S&P 500 ETF (SPY) has fallen from $184.20 per share to $174.17 per share as of the close on February 3, 2014. This has been about a 5.5% drop in value; and many think the damage is far from over. There is good reason to worry this may herald the end of the recent bull market. Since 1871 bull markets have had a median duration of 50 months and an average duration of 67 months. The current bull market has been in force since March 2009 (about 58 months). The bull markets since HFT became a big factor (the last two before this one) have had durations of 57 months and 49 months. This bull market seems right in the sweet spot for an end.
The average drop for a bear market is roughly -40% over 2 to 4 years. B of A / Merrill Lynch (BAC) has already predicted a 20% correction for 2014. Given that major brokerages tend to be bullish, this is an extremely negative forecast.
There are myriad fundamental and economic factors that combined may bring on a bear market:
- The CAPE (cyclically adjusted PE) of the S&P 500 was 24.19 at the market close on February 3, 2014. The median value for the CAPE is 15.90. On this basis the market is significantly overpriced.
- The US Congress still has not approved a debt ceiling hike. This brings the specter of a US debt default into play.
- The US Federal Reserve has begun tapering. Thus far it has cut bond buying activities from $85B per month to $65B per month.
- The sequester cuts, which were supposed to reduce federal government spending by $85B in 2013, actually only reduced federal spending by about $42B. They were supposed reduce federal spending by $109B in 2014; but according to experts they are only expected to reduce federal spending by $89B in 2014. Still even this watered down sequester will significantly increase the negative economic effects due to the sequester cuts. Plus the cuts are supposed to continue in future years for a total of $1.1T through 2021 due to the 2011 Budget Control Act.
- Chinese GDP growth is slowing. It registered only 7.7% growth in Q4 2013. This was very nearly a 14 month low; and many expect Chinese GDP growth to slow further. For instance, the Conference Board, a respected economic forecaster, sees Chinese GDP growth slowing to 7.0% in 2014.
- The Chinese Markit/HSBC PMI fell to 49.5 (indicating contraction) in January 2014 from 50.5 in December 2013.
- The Baltic Dry Index of global trade crashed by 51.5% in January 2014.
- The NYSE Margin Debt hit a high reminiscent of the last two previous stock market crashes and subsequent recessions. Follow this link to an Elliott Wave Analytics analysis of this.
- Recent US economic data has been weak. For January 2014 Ford (F) auto sales fell -7.1% year over year. General Motors (GM) auto sales fell -11.9%. Morgan Stanley estimated that total US auto sales were 15.2 million in January 2014. This was well below the consensus estimate of 15.7 million. Orders for US Durable Goods fell -4.3% in December from November 2013. The US Nonfarm Payrolls Number fell to 74,000 for December 2013. This was far below the recent readings of approximately 200,000. The ISM manufacturing PMI for January 2014 missed badly at 51.3 versus an expected 56.0 (and the previous month's 56.5). The New Orders Index of the PMI slipped from December 2013's seasonally adjusted reading of 64.4% to 51.2% in January. OUCH! Some people are saying this has all been due to the recent "Polar Vortex" weather; but it seems unlikely that that is the more than one half the explanation.
- The EU is still troubled. Public debt in Greece has almost doubled from 115.2% of GDP in 2007 to a projected 200% of GDP in 2014. Portugal's public debt has moved from 75% of GDP in 2007 to an estimated 134.6% in 2014. Spain's has moved from 42% to an estimated 105% in 2014. Italy's is expected to be 131.4% of GDP in 2014. The European debt crisis is far from over.
- The EU credit crisis has led to lower amounts of EU bank lending to emerging markets. Consequently there is a lack of major currency liquidity in many emerging market countries. In many emerging market countries this is leading to instability in both the currencies and the economies. For those countries with both political and economic instability, each is exacerbating the other. The EU credit crises and the many emerging market economic crises are exacerbating each other. A number of experts are pointing to dire situations in Turkey, Thailand, Argentina, and the Ukraine as problem areas that could cause domino effects on many other world economies.
- On January 29, 2014,the Central Bank of the Republic of Turkey raised its marginal funding rate from 7.75% to 12 % the night before the US Fed tapering announcement. The Turkish lira rose 1% against the US Dollar in response; but it had fallen about 14% against the USD in the previous two months. Since May 2013, investors have net sold $3.9B of bonds denominated in Turkish lira. It is hard for a country to operate with a currency that is this unstable.
- In Argentina inflation is rampant. The Argentine peso has fallen from about 0.29 USD in 2009 to 0.12 USD in 2014. In other words it has lost almost 60% of its value over that time. Recently the inflation of the Argentine peso has begun to accelerate (see chart below as of January 29, 2014).
- You can now get 8 Argentine Pesos for a USD; and the inflation only seems to be accelerating. Some feel Argentina should double its already 22% interest rate to ease demand for USD's. JP Morgan (JPM) estimates that the Argentine peso will be worth about 45% less at the end of 2014 than it was at the end of 2013. Naturally wealthy Argentines may wish to safeguard their money in "safe haven" vehicles like US Treasuries. This increases capital outflows, which hurts the Argentine economy further. With economic growth slowing in Argentina, the above is an unsustainable path. It is very worrisome to investors; and they are reacting accordingly. I will omit the facts of Thailand's and the Ukraine's problems, but they too are severe. Plus many other emerging market economies are heading in the same direction.
- Many economists are also worried about the Chinese banking system. The BBC reported on December 30, 2013 that the local government debt in China has risen to $2.9T (up 70% in the last 3 years); and overall government debt has risen to 58% of GDP. The former is the really huge problem. Many local Chinese governments have no way to pay back their debts (or most of them). Plus the pace of rise is alarming to many economists. When you consider that the central Chinese government has tried to severely restrict local government borrowing over that same period, the statistic (70% growth to $2.9T in local government debt over 3 years) is even more alarming.
- China has engaged in a $6.5T lending spree since 2008. In 1999 (a previous Chinese financial crisis year) its bad loan ratios reached as high as 40%. If China saw a repeat of that happenstance, that would translate into approximately $2.6T in bad debts due to the newly issued loans; and that is omitting any loans made from 2000 - 2007, which were substantial. Those could easily account for another $2T in bad debts. The composite $4.6T figure may turn out to be not far away from what China may end up ultimately facing. Remember the local government debt probably has to be 75% or more written off completely. We have already seen approximately $4T in bad debts in both the US and the EU that needed to be written off. Logic dictates that there is a better than even chance that China will end up facing the same circumstances (a debt crisis). Further Moody's Investors Service reported November 5, 2013 that only 53% of the 388 Chinese companies it surveyed in June 2013 have enough cash to cover their estimated debt payments; and Chinese interest rates appear to be rising quickly (see chart below), which will only exacerbate this situation.
- The Chinese 10 year note yield had been rising in concert with other the 10 year notes of other major economies such as the US economy. However, since December 31, 2013 the 10 year US Treasury Note yield has fallen from 3.03% to 2.60% (-43 bps) as of this writing on February 4, 2014; and it may move lower in an apparent worldwide flight to quality. The 10 year Chinese Note yield has been proving stickier. Plus the yield is near the troublesome 5% level that proved critical in many EU debt crisis cases.
- The CBO now says a historically high number of people will be locked out of the workforce by 2021 due to the Affordable Care Act (ObamaCare). It estimates the ACA will lead to the loss of 2.3 million jobs by 2021. The expectation of this future negative plus the problems and uncertainties surrounding ObamaCare right now will likely lead to jobs losses and/or failures to hire in 2014.
All of the above bear watching. A 10%+ correction seems likely near term. Perhaps the correction will be much greater. However, a large correction/crash may take time. The market may bounce on February 4, 2014 after a $4 fall in the SPY to near $174 on February 3, 2014. The market will probably consolidate for a while before moving further downward.
Old UBS pro, Art Cashin, thinks that many traders will push the market up on Friday February 7, 2014 regardless of the Nonfarm Payrolls number. They would blame a bad one on the weather (Polar Vortex). They would rightfully celebrate a good NonFarm Payroll number.
The one year chart of the SPDR S&P 500 gives some technical direction for trading this market near term.
The slow stochastic sub chart shows that the SPDR S&P 500 is oversold. The main chart shows that the SPY has broken through its 100-day SMA. However, it has a good ways to go to get to its 200-day SMA. It could bounce back up to its 100-day SMA. It could find support at its 200-day SMA. It could keep going down through its 200-day SMA. A 10% correction would occur at approximately $165.87 on the SPY, which is currently below its 200-day SMA.
The one year chart of the ProShares Ultra Russell2000 (UWM) provides some technical direction for the small cap section of the market.
This appears to be much the same chart as the SPY chart. Again the descent has been quick. On the last big drop, the UWM took several days to consolidate before dropping rapidly further. We could see the same thing again.
The one year chart of the SPDR Dow Jones Industrial Average (DIA) gives some technical direction for trading the DJIA.
This is much the same chart as the charts above with a big exception. The DIA has broken through its 200-day SMA. This is an extreme sign of weakness by blue chip stocks, especially when compared to the other index ETFs. The DIA seems likely to rally short term after the big drop on February 3, 2014. However, the large amount of downward movement in such a short amount of time leads one to think the damage is not close to being done longer term.
The one year chart of the PowerShares QQQ (QQQ) gives some technical direction for trading the technology part of the US market.
Again the chart is much the same. The one big difference in this chart is that the QQQ did not break its 100-day SMA. It did not even reach it. This seems to indicate that the technology area of the market is stronger than other parts. Investors may wish to pay some attention to that, if they wish to stay invested in stocks.
In sum I am expecting a short term bounce. Then I am expecting some consolidation. Since old pro, Art Cashin, thinks market movers will take the market up on Friday no matter what the NonFarm Payrolls number is, I will be leery of going short in the very near term. However, the damage in this market seems far from done. By next week I may be ready to go short again. There are just too many problems with the world economy; and this market is both overpriced and overbought in the long term. A bigger correction is needed in order to restore adequate confidence in the market.
NOTE: Some of the fundamental financial data above is from Yahoo Finance.
Good Luck Trading.