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1704 On The S&P 500 In 2016? Less Far-Fetched Than Investors Want To Believe

How does a favorable bullish uptrend become an unfavorable bearish downtrend? Does the transition happen overnight? Do commentators, analysts, money managers and market participants simultaneously concur that the environment for risk-taking is exceptionally poor? The transition from “good times” to “bad times” is far more gradual than many realize. Granted, prices on the Dow or the S&P 500 may fall apart in a matter of days, changing the narrative from “no reason to worry” to “don’t panic.” That said, there are a wide variety of indications that forewarn mindful investors six to twelve months in advance , including consecutive quarters of corporate profitability declines, economic deceleration, and waning participation in price gains across the majority of assets and asset types. 1. Corporate Profits Have Been Breaking Down For Quite Some Time . Peak profitability for the S&P 500 occurred with the third quarter results of 2014 (9/30). Operating earnings that exclude “non-recurring” charges like one-time losses and loan write-downs came in $114.5; reported, or actual earnings, came in near $106. Not only will operating earnings decline for two consecutive quarters on a year-over-year basis for 12/31/2015, but reported earnings will decline for three consecutive quarters on a year-over-year basis (i.e. Q2, Q3 and Q4 in 2015). An earnings recession – two consecutive quarters of year-over-year declines is a bad omen regardless of the earnings type that one looks at. According to one researcher, Keith McCullough, two consecutive quarters of declining profits always result in bearish price depreciation for the S&P 500 in the subsequent year. Similarly, I have pointed out in past articles that a relationship between a manufacturing recession via erosion of the Institute for Supply Management’s PMI strongly correlates with declining earnings per share (EPS). In other words, as much as cheerleaders look to play up ex-energy (EPS) or the 65%-70% service-oriented (ex-manufacturing, ex industrials, ex transports) economy, overall S&P 500 profitability weakness goes hand-in-hand with overall economic weakness. The last two bear markets tell the tale. Back in 2000, bulls continued to push the idea that consumers were resilient and forward earnings projections (ex tech) looked phenomenal. They missed the bearish turn of events entirely. Back in 2008, bulls opined that forward earnings estimates (ex financials) were attractive, and that manufacturer health was irrelevant. They missed the housing bubble as well as its subsequent bursting. Here in 2016, bulls are confident that the U.S. can shake off $30 oil, energy company stock/bond woes, a manufacturing recession and a sharp global economic slowdown without a 20% drop for the Dow or S&P 500. Unfortunately, there’s more to the story. 2. The U.S. Economy Continues To Slow And The Global Economy Is Getting Worse . In 2014, I talked about the best way to participate in a late-stage bull market. In June of 2015, I advocated lowering one’s overall allocation to riskier assets . Bearish? Cautious would be a more appropriate description for downshifting from 70% equity exposure to 50% equity exposure. One of the key reasons for reducing risk had been the consistency of the downtrend in the global manufacturing. Here is a chart of JP Morgan’s Global Manufacturing PMI that I described in numerous pieces in the summer of 2015. It should not come as a surprise that U.S. corporate earnings peaked near the top of the PMI Index level in September of 2014. Since that time, a super-strong dollar strangled profits as well as U.S. exports. Meanwhile, Fed “de facto” tightening via tapering asset purchases throughout 2014 coupled with its direction shift in overnight lending rates in late 2015 have strained gross domestic product (GDP) growth. Even worse, Russia and Brazil are fighting off nasty recessions. Japan is there as well. China’s slowdown may be accelerating. Oil producing nations are close to falling apart on $30 oil. And expectations for Europe continue to sink, as debts pile up and international trade diminishes. Indeed, it’s not difficult to spot the pattern on global nominal year-over-year GDP. When it’s negative, market-based asset prices, including those in the U.S., are more likely to deteriorate. What about the constant drumbeat that sensational U.S. job growth proves that the domestic economy is healthy? Not only are the majority of new jobs low-paying, part-time positions, but the erosion of 25-54 year-old workers from the labor force – from 83.5% in 2008 to 81% in 2016 – represents millions of non-retirees who are not being counted. What about the notion that the U.S. consumer is resilient? According to a wide range of resources, including data at Federal Reserve web sites, personal consumption expenditures (PCE) is the primary measure of consumer spending on goods and services in the U.S. economy. Some would say that PCE accounts for nearly two-thirds of domestic spending, which would make it a significant driver of economic growth. Here’s the problem. Year-over-year percent growth in PCE has been declining steadily since May-June on 2014, which is roughly in line with more significant reductions in the Federal Reserve’s asset buying program (QE3). 3. Weakness in Breadth Of U.S. Stock Market As Well As Majority Of Asset Types . By May of 2015, when the S&P 500 hit its all-time record (2130), investors had learned that reported profits had declined on a year-over-year basis – 3/31/2015 ($99.25) versus 3/31/2014 ($100.85). In the same vein, by May of 2015, investors were privy to significant deceleration in Global PMI, U.S. manufacturer woes as well as dissipating personal consumer expenditures (PCE). Yet there was more. The NYSE Advance/Decline (A/D) Line seemed to have peaked in late April. From late April through the August-September correction, the number of declining stocks outpaced the number of advancing stocks. In fact, in late July, market breadth had grown so weak, the A/D Line fell below its 200-day moving average for the first time since the euro-zone crisis – four years earlier. What’s more, less than 50% of S&P 500 stocks could claim bullish uptrends. Equally disturbing, the Industrial Select Sector SPDR ETF (NYSEARCA: XLI ), the iShares Transportation Average ETF (NYSEARCA: IYT ) as well as small caps via the iShares Russell 2000 ETF (NYSEARCA: IWM ) had already entered corrections; all had dropped below respective long-term trendlines. In other words, market breadth was extraordinarily weak. Obviously, a great many folks believed that an October snap-back rally had terminated the volatile 12% correction that occurred in the summertime. Not only did the S&P 500 fail to recover the highs from May of 2015, but virtually all asset types never made it back. And now, most of those assets are actually lower than they were at the August/September lows . Take a look at the widespread carnage that extends far beyond the S&P 500 or the Dow. U.S. small caps in the Russell 2000 (IWM) reside near 52-week lows. The same holds true for commodities via the PowerShares DB Commodity Index Tracking ETF (NYSEARCA: DBC ), Europe via the Vanguard FTSE Europe ETF (NYSEARCA: VGK ) and emerging markets via the Vanguard FTSE Emerging Markets ETF (NYSEARCA: VWO ). Still choose to believe that rapid deterioration across asset types as well as within U.S. stocks themselves is irrelevant? Perhaps some data from the wildly popular Bespoke Research team might provide additional perspective. Internally, the average stock in every U.S. stock classification has already fallen more than 20% from a 52-week high (through 1/11/2016), meaning the average stock is in a bear market. Think this is a mathematical slight of hand because of energy stock depreciation? Wrong again. Every stock sector with the exception of consumer stables and utilities – safer haven assets less tied to economic cycles – is down more than the 20% bear market demarcation line. Is it possible for Amazon (NASDAQ: AMZN ), Alphabet (NASDAQ: GOOG ), Facebook (NASDAQ: FB ), Microsoft (NASDAQ: MSFT ), Home Depot (NYSE: HD ) and a host of influential companies to keep market-cap weighted S&P 500 ETFs like the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ) from sinking 20%? It’s possible. Is it likely? Not unless the Fed has a change of heart on the direction of its monetary policy and not without unanticipated improvements in both corporate profits and the global economic backdrop. For Gary’s latest podcast, click here . Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc, and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert web site. ETF Expert content is created independently of any advertising relationships.

Drilling Down For Bargains After Oil’s Decline

Stocks have suffered lately, with year-to-date returns for U.S. equities once again negative . The most recent driver of the selloff , and accompanying volatility, hasn’t been fears of a Federal Reserve (Fed) rate hike, but rather collapsing oil prices and the implications for energy-related debt. Paying less at the pump might seem like a good thing for consumers, but the recent drop in crude prices has reinforced fears over slow economic growth and deflation, placing pressure on a range of asset classes related to energy . According to Bloomberg data, amid concerns over energy issuers in the high-yield market , high-yield spreads continued to widen last week. The fall in oil is also putting more pressure on already battered emerging market oil exporting currencies , including those of Mexico, Russia and Columbia. Finally, and not surprisingly, any company in the energy space is feeling pressure. This includes not only oil production and service stocks, but also Master Limited Partnerships (MLPs). However, while market sentiment has certainly turned more negative lately, many investors are wondering if it’s time to start bottom fishing, especially with regards to beaten-up energy assets. Considerations for Energy Sector Stocks My take: Though I would remain cautious toward the commodity and believe energy-related names are likely to come under more short-term pressure, I do see longer-term opportunities for those with little or no exposure to energy stocks. The near-term risk for investors is that, regardless of the particulars of the business model, any stock even tangentially related to oil or energy is being thrashed. This is likely to continue to the extent oil prices have more downside. In fact, given the abundance of supply and bulging inventories, I’d be hesitant to call a bottom in oil prices. While I believe that oil supply and demand will start to balance toward the middle of next year, absent a supply disruption from the Middle East or a much sharper deceleration in U.S. production, the simple truth is that there’s still too much oil supply relative to demand. The outlook for Middle East supply remains undimmed, despite growing geopolitical risks. The Organization of the Petroleum Exporting Countries (OPEC) is unable to even set a production target , and Saudi Arabia and Iraq are producing record amounts of oil. Even a country like Libya, with no functioning national government, has dramatically increased production in recent months. Making matters worse, non-OPEC oil production has remained resilient. In an attempt to generate much needed revenue, Russia is pumping a record amount of oil. In the U.S., while production has pulled back from the spring peak, production cuts have been modest thanks to improving efficiency. The number of U.S. rigs is down more than 60 percent from its 2014 peak, but U.S. domestic production is off by less than 5 percent, according to data accessible via Bloomberg. Nor is a surge in demand likely to quickly rescue oil markets. For 2016, global demand growth is estimated to fall to 1.2 million barrels per day (bpd) from 1.8 million bpd this year, as data via Bloomberg show. It will take time to balance out oil markets, assuming we don’t see a more meaningful disruption in supply or a spike in demand, which is unlikely given the sluggish pace of global growth. However, while an imminent V-shaped recovery in physical oil looks unlikely, some of the stocks in this sector may still represent a good long-term opportunity, especially considering that energy-sector valuations are now the cheapest we’ve seen in decades, according to data accessible via Bloomberg. There are two places in particular investors underweight the energy sector may want to start looking to add positions: U.S. drillers levered to low cost production sites and midstream MLPs. 1. U.S. DRILLERS LEVERED TO LOW COST PRODUCTION SITES The cratering in oil prices is hurting any and all energy companies, but I believe those with lower production costs, such as Exploration & Production companies focused in the Permian Basin in west Texas, are better positioned to ride out a period of depressed oil prices. 2. MIDSTREAM MLPS While MLPs aren’t immune to the energy market, as evidenced by the recent 75 percent dividend cut by Kinder Morgan, many MLP businesses are focused on natural gas storage and pipelines. These midstream businesses are less exposed to the daily fluctuation in oil prices. The bottom line: While the energy sector comes with considerable near-term downside, the key for the long term is selectivity and a focus on those names best positioned to survive, or even thrive, in what may be a prolonged period of low energy prices. This post originally appeared on the BlackRock Blog.

No Respite For Oil And Energy ETFs In 2016?

The vicious trading of oil and the energy sector is likely to persist for more months especially after the Fed finally pulled its trigger on the first rate hike in almost a decade. Higher interest rates will drive the U.S. dollar upward, making dollar-denominated assets more expensive for foreign investors, and thus, dampening the appeal for the commodity. In addition, it will make the borrowings, in particular for high-yield firms, costlier and result in less money flows into capital-intensive shale oil and gas drilling projects. This in turn will lead to higher bankruptcies, hitting the already battered energy sector. Following the rate hike announcement, U.S. crude dropped nearly 5% to $35.52 per barrel, just a few dollars away from $32.40 that it hit during the financial crisis in 2008. Meanwhile, Brent oil tumbled to the nearly 11-year low of $37.11, which is not very far from the December 2008 low of $36.20. Analysts expect breaking the 2008 levels could take oil prices to levels not seen since 2004 given fears of growing global glut and weak demand that have been weighing on the oil prices. Weak Trends The latest inventory storage report from the EIA for the last week showed that U.S. crude stockpiles unexpectedly rose by 4.8 million barrels against the expected 1.4 million-barrel drawdown, underscoring further weakness in the energy sector. This is because production has been on the rise across the globe with the Organization of the Petroleum Exporting Countries (OPEC) continuing to pump near-record levels of oil to maintain market share against non-OPEC members like Russia and the U.S. Additionally, Iran is looking to boost its production once the Tehran sanctions are lifted. On the other hand, demand for oil across the globe looks tepid given slower growth in most developed and developing economies. In particular, persistent weakness in the world’s biggest consumer of energy – China – will continue to weigh on the demand outlook. Further, a warm winter in the U.S. will depress demand for energy and energy-related products. Adding to the grim outlook is the International Energy Agency’s (IEA) expectation that the global oil supply glut will persist through 2016 as worldwide demand will soften next year to 1.2 million barrels a day after climbing to a five-year high of 1.8 million barrels this year. ETF Impact The Fed move and the bearish inventory data have battered the oil and energy ETFs and are expected to continue doing so in the coming months with bleak oil fundamentals. In particular, the iPath S&P Crude Oil Total Return Index ETN (NYSEARCA: OIL ) , the United States Oil ETF (NYSEARCA: USO ) , the PowerShares DB Oil ETF (NYSEARCA: DBO ) and the United States Brent Oil ETF (NYSEARCA: BNO ) lost over 3% in Wednesday’s trading session. All these products focus on the oil futures market and are directly linked to the U.S. crude or Brent oil prices. In the equity energy ETF space, the First Trust ISE-Revere Natural Gas Index ETF (NYSEARCA: FCG ) and the SPDR S&P Oil & Gas Exploration & Production ETF (NYSEARCA: XOP ) were the worst hit, shedding 2.7% and 2.2%, respectively. These were followed by declines of 2% for the Market Vectors Unconventional Oil & Gas ETF (NYSEARCA: FRAK ) and the PowerShares S&P SmallCap Energy Portfolio ETF (NASDAQ: PSCE ) . FCG This fund offers exposure to the U.S. stocks that derive a substantial portion of their revenues from the exploration and production of natural gas. It follows the ISE-REVERE Natural Gas Index and holds 30 stocks in its basket that are well spread out across each component with none holding more than 6.95% of the assets. The fund has amassed $161.1 million in its asset base while charging 60 bps in annual fees. Volume is solid with more than 1.8 million shares exchanged per day on average. XOP This fund provides equal-weight exposure to 66 firms by tracking the S&P Oil & Gas Exploration & Production Select Industry Index. Each holding makes up for less than 2.3% of the total assets. XOP is one of the largest and popular funds in the energy space with an AUM of $1.5 billion and expense ratio of 0.35%. It trades in heavy volume of around 12 million shares a day on average (see all the energy ETFs here ). FRAK This ETF provides exposure to the unconventional oil and gas segment, which includes coalbed methane, coal seam gas, shale oil & gas, and sands market. This fund follows the Market Vectors Global Unconventional Oil & Gas Index, holding 57 stocks in the basket. Average daily volume at 39,000 shares and an AUM of $41 million are quite low for the fund while expense ratio is at 0.54%. PSCE This fund provides exposure to the energy sector of the U.S. small-cap segment by tracking the S&P Small Cap 600 Capped Energy Index. Holding 32 securities in its basket, it is heavily concentrated on the top two firms that collectively make up for one-fourth of the portfolio. Other firms hold less than 5.8% of total assets. The fund is less popular and less liquid with an AUM of $33 million and average daily volume of about 19,000 shares. Expense ratio came in at 0.29%. In Conclusion Investors should stay away from the above-mentioned funds as more pain is in store for oil and the energy sector. FRAK and FCG have a Zacks ETF Rank of 5 or “Strong Sell” rating while XOP and PSCE have a Zacks ETF Rank of 4 or “Sell” rating, suggesting their continued underperformance going into the New Year. Original post