With the first month of the new year coming to a close, it's clear that 2015 is shaping up to be quite different from the smooth, easy climb investors enjoyed in 2013 and 2014.
As recently as late December, the market optimism seemed indefatigable as stocks powered to new record highs on hopes for new stimulus from the European Central Bank, solid U.S. economic data and a strengthening tailwind to consumer spending from the collapse of energy prices.
Now, four weeks later, the sky has darkened. Stocks have returned to their mid-December lows, with a retest of the October lows — which represented the most severe selloff since 2011 — looking likely.
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Why?
First, investors are losing faith with the lynchpin of this bull market: The belief in the omnipotence of the world's central bankers. Plus, Greece is riling up the global financial establishment once again.
Corporate profits and outlooks have included some serious disappointments as oil keeps falling to fresh lows and currency market volatility depresses the value of repatriated foreign earnings. Government bond yields are collapsing into negative territory in some areas as part of a flight to safe havens, suggesting bond traders are bracing for a deflation scare later this year.
On top of all that, a weaker-than-expected U.S. durable goods report suggested that the slowdowns in Europe and Asia might be having an effect here at home. Orders dropped 3.4 percent in December, marking the fourth consecutive contraction and the worst reading since August.
In 2012 and 2013, the market uptrend rose out of the ashes of the fiscal cliff scare and relief over the results of the last Greek election, with plenty of help from global central bankers who locked arms and unleashed a wave of stimulus. ECB chief Mario Draghi made his "whatever it takes" promise in July 2012. The Federal Reserve unveiled its "QE3" bond-buying program that September. And "Abenomics" kicked in after Japan’s December 2012 election, with the Bank of Japan unleashing the most aggressive use of cheap money stimulus so far, including the purchases of both stocks and bonds.
Now consider where we are today. The Syriza party in Greece is demanding debt restructuring and rallying against Europe's creditor bloc, led by Germany. For their part, the "troika" of the European Union, the ECB and the International Monetary Fund believes Athens will blink first. A showdown is coming as the Greek crisis that first appeared five years ago enters its final act.
Related: Why Mario Draghi’s Massive QE May Not Be Enough
Global central banks are looking less intimidating after a series of apparent missteps. The Federal Reserve this week recommitted to its mid-2015 window for hiking rates for the first time since 2006, largely dismissing global turmoil to focus on the ongoing tightening of the U.S. job market. Investors feel left out in the cold by Fed Chair Janet Yellen’s emphasizing economic fundamentals over market sentiment, as she well should.
The European Central Bank's eagerly anticipated "Euro-QE" announcement was a dud, with both the size and amount of risk sharing between countries less than overhwleming. The Bank of Japan's yen-destruction strategy still isn't bearing fruit. And, in response to currency volatility, smaller central banks in places like Switzerland, Denmark and Canada have all made surprise moves in recent weeks.
Also weighing on sentiment has been the ongoing disappointment with the fourth-quarter earnings season. With just over 16 percent of S&P 500 companies on the books as of Friday, the overall earnings growth rate stands at 0.2 percent vs. 1.7 percent at the end of the quarter according to FactSet data.
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Drags include the impact of the stronger dollar on foreign profits, overseas weakness and the drop in energy prices. Although these factors were known heading into the reporting season, the actual impact on results has been more severe than expected, shattering expectations — formed by years of seemingly unstoppable corporate profitability — that results would always and forever surprise to the upside.
According to FactSet, S&P 500 earnings per share growth expectations for 2015 stand at 4.9 percent, down from 8.6 percent earlier this month. Moreover, expected revenue growth has been cut in half to 1.5 percent.
Technically, stocks are looking vulnerable here, too, as the S&P 500 falls through the 2,000 level to settle at the low end of its two-month trading range. Yet breadth, or the number of stocks in uptrends, has dropped back to early November lows. That suggests that while the overall market is trying to hang onto recent levels, a further breakdown looks likely.
You can already see the fragility of the situation in the dramatic, gapped declines in major blue-chip stocks over the past week including moves by Microsoft (NASDAQ:MSFT), Caterpillar (NYSE:CAT), Intel (NASDAQ:INTC), Procter & Gamble (NYSE:PG), and Yahoo! (NASDAQ:YHOO).
In response, I've recommended clients embrace a more defensive posture including long bets on volatility. For the more conservative, consider simply raising the cash allocation in your portfolios.
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