My favorite pitchman these days is the most interesting man in the world. A series of Dos Equis commercials features a ruggedly handsome, mature, bearded James Bond/Sean Connery-esque character. He is generally in the company of gorgeous women who are clawing at him. Supremely confident, he ends each ad with the same salutation, "Stay thirsty my friends." When it comes to the stock market this year, the most interesting man in the world who likely knows everything about everything would certainly tell us all to "Stay in cash my friends."
Recoveries are shallow
The first 20 days of 2016 were pretty much a straight line down in the U.S. equity market. The e-mini S&P500 futures contract dropped from 2,035.50 on the final day of 2015 and on January 20, the index traded to lows of 1,804.25 -- a decrease of more than 11%. Since then the index has recovered. Last Friday, the index closed at the 1,940.24 -- just above a 50% retracement of the move but in our opinion, a shallow recovery at best. After the U.S. Federal Reserve announced no change in the Fed Fund rate at their first meeting of the year, the kneejerk reaction of the stock market was to move a touch higher and then close the day in ugly fashion. On Friday, when the Japanese central bank announced that interest rates were going negative, the U.S. dollar exploded higher and stock prices went along for the ride. Last Friday was also month end, a month in which the S&P 500 lost 4.7% of its value. In January, the index has not come close to levels seen at the end of last year. The Dow Jones Industrial Average closed January with a loss of 5.5% and the NASDAQ took a hit of 7.9% for the first month of 2016.
The recovery in stock prices coincided with a tepid rebound in the price of oil, which rose from lows of just over $26 per barrel on January 20 to $33.62 at the end of last week. However, continued turbulence in the Chinese stock market means contagion still weighs on U.S. stock prices. The stock market recovery after the Fed non-action, Japanese announcement and a bounce in crude oil was shallow. The action after the Fed announcement was downright bearish.
Fundamentals are weak
Last Wednesday's Fed statement highlighted many of the issues that continue to weigh on U.S. equity prices. The Fed did not raise rates again in January because of weak U.S. growth. The Fed is monitoring global markets, which are a drag on the U.S. economy. The U.S. central bank expressed concern about market volatility and less confidence about inflation reaching the 2% target. The Fed seemed to downplay falling oil prices as "transitory" and they said that conditions in the labor market continue to improve. Overall, the market interpreted the rate hike pause in January as a continuation of the stated policy in December when they raised the short-term interest rate for the first time in nine years.
In terms of U.S. equity prices, earnings have been lackluster during the recent reporting period -- soft earnings are problematic for the stock market under current market conditions. A strong dollar is likely to weigh on U.S. corporate profits. Add to that a continuation of weakness in the Chinese stock market. Remember, the Chinese government has made no secret of their aggressive intervention in both the equity and currency markets to stimulate the economy but stock prices continue to fall in China. Just imagine how domestic Chinese equity prices would look if it were truly a free market and the government were not changing the rules and pouring billions into the market on a daily basis. The 10 reasons stated for concerns about the stock market in 2016 that I wrote about at the end of 2015 and five reasons provided at the end of the first week of this year continue to point to problems for U.S. equities in 2016. The bottom line is that fundamentals are not pretty and neither is the current technical state of the market.
Technicals point lower
The tepid bounce in stock prices from the lows has come with lower volume. Click to enlarge The daily chart of the e-mini future highlights that volume has decreased on the bounce from recent lows. Although volume was stronger last Friday, it was month end, which is generally a time when volume is strong. Declining volume and rising price is not a bullish technical signal. Volume has been higher on down days and lower on up days. Meanwhile, the long-term chart is telling us that a major correction in the stock market has just begun. Click to enlargeA quarterly chart of the e-mini S&P 500 index illustrates that momentum, which had been bullish since 2009, has shifted with a cross in the long-term slow stochastic this month. Relative strength, which had been in overbought territory since 2013, is around the 60 level at the end of this month and it is now only starting to approach a neutral reading. Momentum and strength of equity prices are both signaling that there remains a lot of downside in the U.S. stock market.
Sentiment has turned
2016 started as a rude awakening for investors. One of the signs that sentiment has shifted in the U.S. stock market is its reaction to the Fed announcement last Wednesday. The monthly missive from the U.S. central bank was dovish -- it clearly stated that future rate hikes are on hold given issues facing the U.S. and global economies.
In the past, equity prices would have rallied on such an announcement. However, this time just the opposite happened. The markets needed more than neutrality from the Fed and stock prices moved lower on Fed Wednesday with the DJIA falling over 220 points, the S&P500 moving 20 points lower and the NASDAQ shedding around 100 points on the session. It took a shock from Japan to rally on the last day of the month.
While the path of least resistance for stocks over recent years was higher, it seems investor sentiment has shifted from buying dips to selling rallies in all of the major indices. Next week, the first week of February, will be very interesting for stock prices, which will likely resume the trend we have seen thus far in 2016.
Stay in cash my friends...
If you are still long stocks, get ready for some ugly statements that will start coming your way soon. Use rallies, like the one we saw Friday, to reduce risk in portfolios and stand on the sidelines. If you have already sold, good for you. While it is tempting to get "thirsty" for equities here at lower prices, avoid that temptation. The evidence remains that the bull has turned bear and we have yet to see the lows.
The most interesting man in the world, with his wealth of knowledge and extraordinary perceptive capabilities, would tell you to "stay in cash my friends." The Carden Smart Hedge™ Index systematic signal switched to cash on December 11, 2015 when the S&P 500 index was trading at 2,012.37. On Friday, January 29 just six weeks later, the S&P 500 closed at 1,940.24 -- a decrease of 3.6%. The index, like the world's most interesting man, remains in cash. The methodology will yield a "thirsty" signal at some point in the future when stability returns.
Stock market exposure at this time comes with elevated risks. It is a rough start to 2016 and the real carnage may have not yet begun. Stay thirsty for a refreshing libation, not for stocks.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.