Subscribe to Money Morning get daily headlines subscribe now! Money Morning Private Briefing today's private briefing

Here's How Low the S&P 500 Could Go in This Bear Market

The bear market deepened last week as investors sold everything that wasn't tied down that had the faintest tinge of risk associated with it – stocks, commodities, junk bonds, you name it.

The Dow Jones Industrial Average lost 358 points, or 2.2%, to close below 16,000 at 15,988.08, while the S&P 500 fell 42 points, or 2.17%, to close under 1,900 at 1,880.33.

But losses could get even steeper from here…

Nasdaq's FANGs Faltered This Week

The Nasdaq Composite Index dropped 3.3% to 4488.42 as the so-called FANGs – Facebook Inc. (Nasdaq: FB), Amazon.com Inc. (Nasdaq: AMZN), Netflix Inc. (Nasdaq: NFLX), and Alphabet Inc. (formerly Google Inc.) (Nasdaq: GOOG) – all got de-FANGed, with Amazon losing another 6.1% on the week to fall to $570.18, more than 100 points lower than it started the year; Google/Alphabet dropping 2.8% to 694.45, down nearly 80 points year to date; Netflix down 6.6% to $104.04 on the week and 9% on the year; and Facebook down 2.4% on the week to $94.97 and down 9.4% year to date.

Rather than drag up the rest of the market, the FANGs are being pulled back to reality by the bear market that now has most of the stocks in the S&P 500 trading 20% or more below their 52-week highs.

Readers keep asking why I believe we are in a bear market. The reasons are simple: China is a house of cards whose debt-engorged economy hit a wall in mid-2014 after seeing its total debt grow from $7 trillion in 2007 to $28 trillion (it is now probably over $30 trillion). This then caused global commodities markets, which were inflated by the Chinese debt explosion, to collapse.

The last piece of the puzzle was the end of the Federal Reserve's quantitative easing (QE) program in October 2014 and the beginning of its effort to raise interest rates in 2015, though this didn't occur until last December and is more likely than not to be reversed in 2016 if markets continue to sell-off and the U.S. economy continues to weaken.

After ZIRP, Bear Markets Behave Differently

Many observers argue that we can't have a bear market unless the U.S. economy enters a recession or the Fed begins to aggressively tighten interest rates. I've been writing for more than a year in The Credit Strategist that this thesis needs to be questioned when interest rates are at zero as they have been for the last seven years.

I think the markets answered that question last year by rejecting that thesis – we entered a bear market in 2015 as most stocks in the S&P 500 fell by at least 20% from their 52-week highs.

Only the capitalization-weighted headline index failed to fall that much due to the performance of the FANGs and a select group of other stocks, like Walt Disney Co. (NYSE: DIS), Microsoft Corp. (Nasdaq: MSFT), and Starbucks Corp. (Nasdaq: SBUX). With those stocks starting to falter badly, however, the index is quickly joining the rest of the crowd.

Another indicator that a bear market is upon us is the horrendous performance of credit markets.

The high-yield bond market fell apart in 2015 and got worse in January. The average yield and spread on the Barclays High Yield Bond Index is now 9.22% and 722 basis points, respectively, a jump of 0.48% and 62 basis points since the beginning of the year.

Not Just Trouble, but Bad Trouble

The sectors that led the way down, energy and basic industry, are in deep distress. The average yield and spread on the energy sector is 17.26% and 1,444 basis points, respectively, while the average yield and spread on the basic industry sector is 14.01% and 1,172 basis points, respectively.

Investment grade spreads have also blown out to 167 basis points from 120 basis points a year ago. It has become much more expensive for Corporate America to borrow, which means that the days of borrowing endless amounts of money to buy back endless amounts of stock are over.

In view of the fact that stock buybacks and quantitative easing (QE) were the two props holding up stock prices, the markets are likely heading lower – likely much lower.

Treasuries acted as a safe haven as the stock market fell apart last week. The yield on the 10-year Treasury dropped to 2.03%, and the yield curve moved to its flattest level since 2009.

A flat yield curve indicates a slowing economy. Treasury yields would likely be lower but for the fact that China has been selling part of its huge reserves in order to bolster its markets, which have dropped more than 20% from their 52-week highs and have clearly embraced the bear.

China is in serious trouble with little sign that conditions will improve anytime soon.

The question is whether China and its commodities bubble will take down the world like the United States and its housing bubble did in 2008. Nobody can answer that question with certainty, but we do know that there is more debt and more geopolitical instability today.

On the flip side, U.S. banks are much better capitalized and in a much better position to handle a global sell-off. For the moment, the most likely scenario is that markets continue to sell off but that we experience something less severe than 2008. But that could still mean large losses for investors.

I am lowering my 2016 S&P 500 forecast from 1,875 to 1,900 to 1,650 to 1,750, which means that I expect the market to hit those levels sometime in 2016. Investors should reduce or eliminate their equity exposure and wait for better days.

There is no reason to sit and try to pick up nickels in front of a steamroller.

Get Michael's Sure Money investor service for his favorite ways to make money and stay safe in this bear market. You'll get specific stock and strategy recommendations twice each week. There's no charge for Members, and you'll receive his Super Crash Report, too. Just click here.

Join the conversation. Click here to jump to comments…

About the Author

Prominent money manager. Has built  top-ranked credit and hedge funds, managed billions for institutional and high-net-worth clients. 29-year career.

Read full bio

  1. Pauline Wong-Felix | January 17, 2016

    If we ate on a bear market everything is blown to pieces by the glut then why should yours be any different?

  2. David Allen | January 17, 2016

    Interesting.

  3. Eben Calder | January 17, 2016

    Common sense. The talking heads on the street will always stress the positive in order to keep promoting. But all bull markets end and always correct. Lewitt adds a practical perspective on the bond and credit side that many cannot easily factor in. Added to this is the collapse of the commodity bubble. And, of course, well based suspicion over China, given her financial system is not opaque, and hides many sins. Over time, other issues will increasingly come into play. World population is at or headed to 0 in all of the more developed world that accounts for most consumption. The Information Age is remaking the industrial age and in the process, its smart machines are replacing the middle class which rose in the industrial age because its labor was essential. Now, it's share of wealth is declining. Neither it nor population will generate future growth. Growth has already essentially flattened, other than that related to inflation and debt related attempts at expansion. For now, we have a market correction. For the future, we have a rising chorus that supports the Trumps who no longer have a voice – or a place.

  4. Larryfleisher | January 17, 2016

    How come Sunedison is in the toilet very disapointed

  5. silveslicker | January 19, 2016

    What about gold and silver?

  6. David | January 19, 2016

    Michael you talk nothing of the wars going on?The potential for Saudi Arabia to disrupt the world by ending their peg to the petrodollar?You sar are banks are better capitalized?Lets say there are 13 trillion dollars on deposit…individuals and small businesses for things such as payroll,restocking inventories etc.How much of that is protected ?All for the bank and none for the depositor.FDIC has 67 billion in their fund and a 500 billion credit line with the Treasury.How are banks well capitalized?They are more leveraged than in 2007 and 8 and no one talks about the canary in the coal mine….shadow banking with hundreds of trillions of derivatives.What if FASB made the banks mark to market?What if a swap or energy derivative pops and creates a cascading effect? China is got growing pains but are you telling me that the USA does not intervene or allow free market practices such as real price discovery and China is unique in this area??Think Exchange Stabilization fund(ESF) started in 1934 with seed money from the FDR gold seizure.Well that fund RUNS THE WORLD.It is part of the USA Treasury.What about the PPT?You may want to see how much USA securities were off loaded in 2015 and tell me where the problem really lies.It's a cyclical shift of financial power,a repudiation and loss of respect of the USA hegemony and all parties including some aspects of the USA are preparing for this.The Titanic can not turn on a dime.

  7. Dom chiocchio | January 20, 2016

    Mr. Lewitt could you please do an article on the viability of a solar installation say in the 20 to 50 KW. range as to initial cost of all required equipment +installation. Solar energy may be free just like water but I like to think that to manufacture all the related parts, installation, maintenance, required space, and occasional replacement items to the system one would most likely be better off with the utilities than with solar.
    I would consider this to peace of mind.

    I would like to know what middle man is employed in stock trading in order to make a transaction to take place between a buyer and seller
    other than a brokerage firm and the market place?
    I enjoy your articles and look forward to a response to the above. Thanks:
    Dom

Leave a Reply

Your email address will not be published. Required fields are marked *


Some HTML is OK