Maybe 2016 will be one to forget on Wall Street. Investors continued to react on Thursday to a sudden hawkish turn by the Federal Reserve by pushing large-cap stocks below three-month support levels. It looks like the start of the first significant downtrend since January.
Yesterday’s loss of 0.4 percent for the S&P 500 landed the broad-market index in the red for the year-to-date, joining the Russell 2000 and Nasdaq in that sorry place. The blue-chip Dow Jones industrials index is now up just a scant 10 points from its year-end 2015 level of 17,425.
With stocks trading in a sideways range since late 2014, Wall Street looks headed for another bout of volatility as traders — who have grown addicted to the Fed’s easy-money largesse — throw another temper tantrum over monetary policy normalization. As a result, investors should be prepared for the growing likelihood that 2016 finishes the year in the red.
There’s surely a lot to be worried about. Economic data is uneven. Corporate earnings are falling at rates rarely seen outside of a recession. Political tensions are high as the country plunges into what’s shaping up to be the most divisive U.S. presidential election in modern history. Global trade volumes have been dropping for the past two years.
And there’s a big credit overhang, both in terms of corporations (which have borrowed heavily to fund stock buybacks) and governments (the eurozone debt crisis, the Chinese credit-based stimulus and more).
The Fed’s newfound aggressiveness is just adding to this list.
Both the April Fed meeting minutes released on Wednesday and a cavalcade of individual Fed speakers have all sent the same message: The market’s one-and-done rate hike expectations for 2016 were too low, and the Fed could make as many as three or maybe even four quarter-point hikes this year, starting in June.
New York Fed President William Dudley said that a June or July tightening would be reasonable given a second-quarter rebound in GDP growth. And Richmond Fed President Lacker said the market overestimated how likely the Fed was to pause its tightening campaign. He added that rates could’ve been raised in March and April, and that he would be comfortable with four rate hikes this year.
All of this, of course, assumes ongoing stabilization in inflation and continuing strength in the labor market. But with crude oil trading higher and job openings near record highs, this looks assured.
The market’s vulnerability has caught the eye of a number of Wall Street analysts:
- Goldman Sachs strategist David Kostin told CNBC last week he had turned bearish and that it was time to play defense in “a tough market” on concerns over profit margins, waning buybacks and other negative factors.
- Marko Kolanovic at JPMorgan, a “quant” analyst, is worried about high leverage and waning liquidity on the trading exchanges that could exacerbate any market decline.
- Bank of America’s Michael Hartnett is a “seller of risk” on fading U.S. business optimism and falling profitability.
- Citigroup’s Matt King is worried this “is the tipping point” where central bankers lose control of the situation.
- Michael Riesner and Marc Muller at UBS have warned clients of a likely market swoon into the June-July time frame after a short bounce into mid-May based on technical momentum indicators.
When pros like these are concerned, it’s time to reconsider your risk tolerance and downside exposure, and trim positions where needed.