The market has seen some tough times since the start of 2016 – stocks bottomed in mid-February, and then ripped higher for the following three months.
The sharp rally, though, seems to be running out of steam.
It is, therefore, the perfect time to re-visit my list of 7 Things Investors Need to Pay Attention to in 2016 from an article I wrote for Wall Street Daily, based on my market experience, dating back to the 1980s and includes the 1987 stock market crash.
Now that we’re five months into 2016, it’s time to take another look at the seven things investors need to pay attention to for the rest of the year, in order of importance.
Number 1: Central Bank Policies
Unfortunately, central banks’ policies remain at the top of the list.
Both the Bank of Japan and the European Central Bank remain lost in Wonderland with Alice as they maintain their negative interest rate policies.
Incredibly, we now have about $10 trillion worth of sovereign government bonds that trade with a negative yield!
As for Janet Yellen and the Federal Reserve – famed hedge manager Stanley Druckenmiller best summed up their policy, saying, “The Fed has no end game. The Fed’s objective seems to be getting by for another six months without a 20% decline in the S&P and avoiding a recession in the near term.”
Before retiring in 2010, Druckenmiller averaged an amazing 30% gain annually over a 30-year career. His assessment, with which I agree, means we can expect more “unconventional” policies from the Fed, in an effort to prop up markets.
Number 2: Currency Wars
Second on the list is the currency “cold war,” which is a direct consequence of central bank policies.
Recent attempts by the Bank of Japan and the European Central Bank to weaken their respective currencies have backfired with both the yen and the euro only rising in value.
That puts the focus squarely on the Fed, which has, clearly, painted itself into a corner.
If the Fed remains dovish and doesn’t raise rates, the dollar will weaken. This helps U.S. multinationals and emerging markets. However, it would be devastating to Japan and Europe.
If the Fed manages to normalize rates – as it should have done two or three years ago – the dollar rises. This would help Europe and Japan but hurt emerging markets. It would also damage many of our multinationals, which, in turn, knocks down the stock market.
Number 3: European Banks
Sadly, with the situation in European banks staying unimproved, they remain third on the list of things investors need to keep an eye on, for the time being.
Some of the big banks are just too highly leveraged.
The leverage poster child is Deutsche Bank (DB). It has taken the mantle of having the world’s largest derivatives book from American banks. Add to that the loads of loans DB has doled out to troubled energy and mining companies – not to mention Volkswagen.
Furthermore, there are systemic problems, which negative interest rates have only exacerbated.
Leading the way in the downfall, however, are Italian banks. They have the highest proportion of bad loans of any G20 country.
The sector has €200 billion in loans to insolvent creditors, €83 billion of which has yet to be written down. The fund orchestrated by the Italian government, using private funding, set up to help the banks – Atlante – is simply too small.
Atlante, which means Atlas, only has €4.25 billion in assets. Unlike, its impressive namesake, this sum is hardly enough to hold up the banks, much less support the Earth on its shoulders like the mythological Atlas.
Number 4: The United States’ Election
The U.S. election was originally ranked sixth on this list, but as the race heats up and front runners begin pulling away from the pack, the November Presidential election becomes increasingly critical.
As we move toward polling day, Wall Street can be expected to focus more and more on the implications of a Clinton or Trump presidency.
Specific market sectors are certain to be affected by either candidates’ economic policies.
Both Clinton and Trump are likely to push for a minimum wage hike, as soon as possible. And both candidates want to limit drug price increases. These, along with stances on trade and taxes, will create waves in the market that will, ultimately lead to a ripple effect – one thing influencing another, influencing another, and so on.
These implementations may lead to further weakness in the retail and restaurant sectors, as well as the pharmaceutical and biotech sectors, to name just a few.
Number 5: Oil
The concern for the oil market, on the other hand, has dropped from fourth to fifth on my list – though that may prove temporary.
Concerns over oil are two-fold.
First, Wall Street is completely on one side of the trade here. Just two weeks ago, there were a record number of futures and options positions betting that oil would continue rising, and those numbers have only changed slightly since then.
Crowded trades have a tendency to become bad trades.
Further, the other concern is fundamental: There’s still a glut of supply.
Despite endless talks of a freeze in production, all the big players only have plans to lift their output in 2016. This includes Iran, Iraq, Russia, and the Saudis.
Meanwhile, in the U.S., we have fracklog.
If oil hits $50 per barrel, some of the 4,000 fracklogged wells will be brought online.
According to Bloomberg, it only takes about 80 days on average for such a well to begin producing. It adds that if the fracklog backlog were reduced by just 170 wells a month, another 500,000 barrels per day would be put into the market.
That’s an extraordinary increase to an already excessive oil supply that could severely affect the energy industry.
Number 6: China
Concerns regarding China have also decreased – dropping from fifth to sixth on this list of concerns.
While there will still be China “scares,” as it transitions to a more consumer and services economy, it’s crucial that investors realize that these sectors now contribute 57% of China’s GDP.
Since 2012, the services sector, alone, has been rising 8% annually in real terms.
Here’s just one example: China’s box-office revenues soared nearly 50% in 2015 to $6.8 billion. Within a few years, China will entirely surpass the U.S. in that category.
During my time in the investment business, I have heard numerous predictions of China’s economic demise.
Hedge fund manager Kyle Bass predicts a huge devaluation in its currency. Such prophecies, however, come and go while China’s economy continues steaming along.
Number 7: Reversion to the Mean
In my previous article reviewing this list, I noted that 2016 would be a year known for its reversion to the mean. In other words, the past years’ winners would turn into losers and vice versa – the system would level itself out.
But not even I could anticipate the rapidity of this move.
Tech and biotech stocks have stumbled. Meanwhile, natural resources stocks have soared.
The problem is now that Wall Street is, once again, on the same side of the boat. Many traders are short the U.S. dollar, and long commodities like oil and the related stocks remain in the so-called reflation trade.
When a trade becomes a consensus trade, it’s time to get out.
Keep an eye out for oil and industrial metals prices to weaken. When this happens, it will drag down the related stocks.
Do not, however, look for old favorites to revive, either. The old FANG stocks are now down to two very crowded companies: Amazon.com Inc. (AMZN) and Facebook Inc. (FB). Even WSD’s own Louis Basenese warned tough times may lie ahead for Facebook.
Any turmoil, however, will serve to keep a bid under gold, which is up 20% this year.
Financial markets in 2016 will continue to be challenging. As the landscape continues to change, I will be sure to report back on each of these volatile issues. Stay tuned for an update after the year’s next quarter.