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Should I Stay Or Should I Go?

|Includes: AAPL, AMZN, CVX, JWN, M, MSFT, TGT, WMT, Exxon Mobil Corporation (XOM)

Bon Jovi's song poses an interesting question in the stock market today: should you keep your holdings or is it time to sell? It's been a rough November so far, with the Dow Jones (^DJI) falling 673 points (3.76%) from 17,918 on Nov. 3 to 17,245 after close on Nov. 13. And especially after the correction in late August, there are worries in the market as to where it is going. Is this just a correction (>10% drop), or could it be the beginning of a bear market (>20% drop)? After observing charts for the Dow Jones, S&P 500 (^GSPC), and Nasdaq (^IXIC), the drop in several major sectors, the slowdown overseas, and overall consumer sentiment, I believe we could be heading towards another recession.

The Indices

(Dow Jones (blue) and S&P 500 (red), 1995 - 2015, Yahoo! Finance)

As indicated by the 20-year chart for the S&P 500 and the Dow Jones, the indices peaked in Jan. 2000 and another in June 2007, followed by heavy declines. If the 7.5-year pattern holds, we are overdue for a decline. Secondly, the recent movements of the Dow and S&P 500 show a rounded top, an indicator of a possible turnaround. And lastly, there has been high volatility recently: there is large price fluctuation and there is mixed buying and selling of roughly the same volume, indicating uncertainty in the market (shows below in the 2-year Dow Jones vs. S&P 500 chart).

(Dow Jones (blue) and S&P 500 (red), 11.15.2013 - 11.13.2015, Yahoo! Finance)

There are similar patterns in the Nasdaq Composite, but more extreme in the early 2000s because the Nasdaq measures the technology sector:

(Nasdaq Composite, 1995-2015, Yahoo! Finance)

(Nasdaq Composite, 11.15.2013 - 11.13.2015, Yahoo! Finance)

Market Sectors are Falling

(Sectors and their Growth Rates, Fidelity Investments)

This is one very plausible cause of a market drop. Beginning one year ago, most of the sectors turned to the red. Information Technology (includes industries such as software, hardware, semiconductors, and communications equipment) was one of the sectors that performed well until recently, while other sectors such as Energy and Telecommunication Services began falling 3 years ago. Strong indicators of sector weakness are Exxon (NYSE: XOM) and Chevron (NYSE: CVX) for Energy; Walmart (NYSE: WMT) and Target (NYSE: TGT) for Consumer Staples; and Macy's (NYSE: M) and Nordstrom's (NYSE: JWN) for Consumer Discretionary.

One possible counterargument is that consumer spending has increased, so the sectors should turn around. I agree that consumer spending has steadily increased, but because the consumer spending increase and the sector performance fall have both been happening for the past two years, it is unlikely the increase in spending now will improve the market. The main cause for increased spending is an increase in wages not matched by an increase in the inflation rate, which has remained close to 0%. A stagnation in the inflation rate is usually not a sign of economic growth, which is worrying. And speaking of raising rates, the Fed might do so in December, which is currently reducing consumer sentiment. More on that later.

European and Chinese Economies Slowing

International conditions can definitely affect the US, and the current conditions overseas won't help the situation in the US. The US is heavily tied to Europe and China - the correction in late August caused by China devaluing its currency is a perfect example - and so effects overseas can greatly impact the US. Exports from European nations, led by Germany, fell this past month, combined with negative numbers in Greece, Finland, and Estonia. Overall, the EU stated its GDP was 0.3% higher than the last quarter's, but the quarter-to-quarter growth rate is less than the 0.4% it was in the second quarter. The ECB may enact its stimulus plan given the weak growth. Weak growth in Europe will have a negative effect on the US because it is one of the main importers of European goods, and Europe is one of the main destinations for US exports - just as the 2008 recession in US affected the world, the world can affect the US (http://www.wsj.com/articles/french-economy-returns-to-growth-in-third-quarter-1447396675).

Consumer Sentiment

Ah, the grand, overarching, cause for stock fluctuation: consumer sentiment. If consumers aren't feeling too good about the market and decide to sell, the market tanks; if they are optimistic, the market goes up. Right now consumer sentiment is high, recovering from a low in August with optimism after successful earnings from Apple (NASDAQ: AAPL), Amazon (NASDAQ: AMZN), and Microsoft (NASDAQ: MSFT), to name a few.

(Michigan Consumer Sentiment Index, Advisor Perspectives (University of Michigan))

The CSI has reached a resistance level, though, and might fall back down. Some possible causes of a sentiment drop:

  1. Fed has repeatedly said it might raise interest rates in December (next month! Wow, time flies), and this has caused worry in the market
  2. Recent drops in stocks and indices
  3. Slowdown overseas

If consumer sentiment falls, stocks fall too.

Counterarguments

One possible counterargument is that the average income is increasing and the unemployment rate is decreasing, which are positive signs. That is true, but average income is mostly increasing because the low inflation makes the real salary essentially equal to the raw salary. And regardless, the household income (median household income, that is) has not increased significantly, as indicated by a graph from the Census Bureau:

(Real Mean Household Income by Quintile, Advisor Perspectives (Census Bureau))

Also, the unemployment rate is currently low, yes, but that did not stop the 2008 recession from happening. According to this graph from the Bureau of Labor Statistics, the current unemployment rate is almost exactly the rate at the end of 2007, when the indices started declining.

(Labor Force Statistics from the Current Population Survey, BLS)

Another counterargument is that the inflation and interest rates are so low that they cannot go any lower. Well, low inflation and low interest rates usually are not a sign of economic growth, and economic growth is what counters bearishness in the market.

(Monthly Inflation Rate, 1999-2015, US Inflation Calculator)

Lastly, holiday season should help, right? I think it should, but looking at charts for the major US indices as they entered a recession, November and December did not reverse the downward trend.

Conclusion

Do not worry too much - just keep an eye on the market and remain cautious. A bear market may be coming, but it would not arrive for several months. Most important is to not panic: panic always makes the situation worse! A "Panic of 2016" (there's probably not enough time this year to have one) would be terrible indeed.