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This Is A 2011 Like Correction


Earnings recession and Oil slide is the root cause and they both are still in play.

S&P should trade around 1830 in the next 3 to 4 weeks.

Current negativity affects Q1 earnings and this becomes a loop resulting in a very bad 2016 for stock market.

This is my first article in seekingalpha. I have been a member here for over one year and read articles here on the weekends. More than the articles themselves, the comments offer valuable inputs that help you make a better investor. So I welcome detailed comments. My theory in life and investing is to keep it simple. I am not a research analyst, but I will make every effort to explain my reasoning behind my statements. I am successful in my personal investments last year and also thus far in 2016.

Causes behind January 2016 stock market meltdown:

In my opinion, there are three causes behind the stock market correction we have witnessed in January :

1) 2015 was not good for earnings and things have clearly slowed down in Q4. Many investors are anxious about the earnings recession that is going to be very clearly visible in Q4 earnings.

2) In December the fed has started rising interest rates and it has mentioned that there could be 3 to 4 rate hikes in 2016. This is a result of Fed wanting to normalize it's balance sheet and at the same time maintain transparency. Fed clearly believes that US economy has recovered fully and it's on it's way to growth.

3) Oil supply exceeding the demand mainly due to slowness being experienced in China. This resulted in continuation of the downward pressure on oil prices. The oil price decline has accelerated in January because of lifting sanctions on Iran and also because Dollar has started strengthening after Fed's December rate hike.

In reality, the downward slide for stock market should have started right after the Fed's December meeting, but the optimism about Santa Claus rally has delayed this to the beginning of January. When January began, the first thing that investors thought is beginning of dreaded Q4 earnings and that has started this stock market sell-off and there was no looking back until Russia and Saudi Arabia began giving some statements about production cuts and BOJ shocked the investing world with a surprise negative interest decision that panicked the shorts into massive covering. The institutional investors joined the rally on Jan 29th to improve the monthly portfolio performance on the last day of the month. The BOJ decision appears to be a coordinated effort between central banks to prevent stock market sell-off after the shocking Q4 GDP report.

What's the future direction :

From the beginning of the year, the market is behaving like it's in a bear market. This resembles like September 2008. It's quite common that there will be some strong counter trend rallies in bear market. They will be quite violent like the one we saw on Jan 29th and Feb 12th. We saw similar ones in September and October 2008 due to some Fed interventions. In 2008, ultimately stock melt down continued till it hit the low in March 2009 when all the indices are off by 50%. I believe that we are in for s similar situation now except for a relatively smaller scale. This has to run it's course. One can only slow this down with some interventions from Russia or Saudi Arabia or Feds. But enough damage has already been done to general psyche. Both companies and public will be cautious about spending in this situation. Two out of the three causes behind this meltdown will remain valid for a few more months. The only condition that may not be valid anymore is the Fed rate hike fear. It is not valid any more. As a result, the market correction may only slow down as the other 2 causes are still very much valid. The market reversal will happen if 2 out of the 3 conditions reverse. That means either earnings have to improve in Q1 or oil demand has to outstrip oil supply. I do not see either of this happening till the second half of the year. So the market should continue to grind down slowly.

Trading Ranges:

An interesting thing about this market is that the case for the bear market is not strong enough, yet the case for a bull market is even weaker. So bears have a slight but visible edge here. This will put overall market in the downward direction till the oil demand increases and monthly economical indicators start showing strong numbers. Volatility is not going away any time soon. It's a dream market for traders, not for investors. As has been happening for the past few weeks, I believe that all rallies will be sold into. On the upside, S&P has been witnessing strong resistance at 1945 and it should continue to do so. On the downside, S&P might hit 1780 at some time within the next month (before mid March) to form the temporary bottom. I do not see it being breached till the beginning of Q1 earnings in mid April. Once the Q1 earnings start pouring in, the stock market should come under pressure again, this time it will hit absolute bottom for the year, somewhere between 1600 and 1700. The period between March 15 and April 15 should be good for the bulls. They can take it from the low of 1780 to a high of 1950. The last few weeks have seen S&P trading around 1880 (moving 50 points on either side) and I would think it to move around 1830 (moving 50 points on either side) for the next 3 to 4 weeks.

Conclusion / Predictions :

I am convinced that we will see S&P at 1700 in the next three months. I am not sure if we can avoid a recession. That depends a lot on China's turn around. If China goes into the kind of recession that US went into in 2008, then the stock market sell-off will accelerate and we will be revisiting the 20% sell-off situation we have seen in 2011. That puts the S&P at around 1600. Bottom line is that, there is no place for optimism in the first half of the year. I do not expect the Q1 earnings to be any better than Q4 earnings. The major indexes will be dragged by the energy companies again. Things should start improving from Q3 onwards and I will S&P at 1900 (plus or minus 1%) by the end of the year. But we should revisit 2050 at some point in Q4 before settling around 1900. So the year won't be bad overall, but the first half will definitely be challenging. As for Gold, it should be a good year. I am long gold and I will ride it till Gold hits 1350. I am expecting that we will hit that number by mid March.

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.