In prior years since I've started this blog most of the time I would look upon the new year and have a decent sense of what lied in store because there were at least a few major indicators that suggested the bull market since 2009 had room to go. I was generally bullish long term and always suggested to give the bulls the benefit of the doubt during corrections. I advocated buy and hold as a result. This time around I can't say that because we are in a situation where corporate profits as a whole are rolling over and monetary conditions are tightening which are not the ingredients for an advancing bull market that is 6 years old. At the very least this suggest the bull market will be on hiatus characterized by choppy action for months with a reasonable possibility of a full blown bear market. The bulls would argue that profits have only rolled over marginally (so far) with energy and the strong US dollar as the culprits and although interest rates are now on the rise, we're a long way from monetary policy being restrictive.They can also argue that with energy being so oversold it's poised for a bounce back which would be positive for overall corporate earnings in 2016. These are a good points, however, the burden of proof is now on the bulls and until we actually see evidence of earnings turning the corner for the better, investors will be skittish. Also, with the fed in tightening mode there is always going to be the fear that they will over do it and cause the economy to tip into recession not to mention the belief many have that this entire bull run was predicated on the fed's easy monetary policy which is now being unwound. As a result of the above, the market will have a very hard time making headway and the best we can hope for would be a range bound market. 1994 and 2004 were the last times the fed tightened monetary policy for the first time coming out of recession and although there was ultimately a bullish resolution, the markets were range bound for months as investors took a wait and see approach to see what kind of economic damage if any, the tightening would do. Once the market got the sense that the fed was just about done with little or no damage to the economy, the markets took off. Will this happen again this time around? We will see....I think it's certainly doable but then there's the bear case which is not weak by any means.
There is an eerie parallel of the energy crash to that of the tech and housing crashes of 2000 and 2007 respectively which lead to recessions and major bear markets for stocks in general. Both those aforementioned sectors were important drivers of the cycles that preceded them, responsible for significant earnings and job creation. When they crashed they created stresses in corporate bond markets and resulted in job losses which at first were dismissed as isolated events that wouldn't spill over to other sectors. Energy state Texas was by far the greatest contributor to job creation in the US since 2009. In fact about 40% of all job creation in the US since 2009 was due to Texas!
To believe that this prosperity in Texas was not due to the oil boom would be very naive. I've heard the argument that Texas is no longer as energy dependent as they once were as their economy is more diversified but I'm quite sure the energy sector in Texas leads their economy and drives other important sectors such as housing and retail - it certainty can't be the other way around. Now that the oil sector is in the tank we are at serious risk of seeing the reverse of this Texas wealth effect kick in.
There is a silver lining to the oil crash in that it's an economic windfall to consumers which is different compared to the tech and housing crashes whereby there's no such windfall. I'm not sure that's going to be enough to offset the negatives but at least there is a positive effect.
The bottom line though is that flat/down earnings when there's monetary tightening is simply not a good recipe for bullish action when you have the market trading at arguably high valuations. I think the best the bulls can hope for at this point is a range bound market but as I've mentioned many times on this, I never felt we reached the euphoria stage of this bull market and people are always so quick to turn negative at the first hint of trouble and so the contrarian in me is not writing off this bull market yet, however, for the first time in a long time, I'm giving the bear case a lot of respect. Be careful.
