It was definitely a “rough and tumble” week for the stock market, and while bulls were hoping for a Friday bounce, that was not to be the case. The roller-coaster action we saw this week was painful, and Friday’s nearly 400-point drop in the Dow Jones Industrial Average did little to boost investor confidence. Intel’s (INTC) 9% drop on Friday alone only added to investor concerns, but when the dust settled, it was not all that bad of a week. The Dow and the S&P 500 fell by about 2% each, while the tech-heavy Nasdaq finished the week about 3% lower. Thursday’s bounce had bulls thinking the worst was over, but Friday’s slide had most bulls scratching their heads.
The worries are clear, and the economic slowdown in China was front and center. China’s recent news of a manufacturing slowdown was compounded by news that a decrease in bank loans signaled that all was not well in the second-largest economy in the world. China’s Shanghai Index lost 3.5% on Friday alone, and it is down about 20% from its late-December, near-term highs. This is not the type of global environment that inspires investor confidence, and U.S. stocks responded accordingly. When China sneezes, the rest of the world might catch a cold, and that was cause for alarm for investors across the globe.
It did not help matters to see the price of oil continue to decline, and having crude prices fall by 4.8% on Friday to close below $30 per barrel, only added to the dire mood on Wall Street. We recently had warnings from strategists that oil prices below $40 per barrel could have a negative impact on the global economy, but now that oil is below $30, it has opened a new can of worms. Calls for oil falling to $20 per barrel or less are only exacerbating concerns that this meltdown in oil prices could really hurt the global economy. Yes, gas prices at the pump will be lower, but the ramifications for the global economy are significant.
So aside from China, falling oil prices, and weakening U.S. earnings, we have a Federal Reserve that began raising interest rates in December. Granted that the Fed only raised rates by a quarter of a point, but it was still a rate hike. Critics of the Fed have already said that its “telegraphing” of three-to-five more rate hikes might have been a mistake. Having rates held near zero for years has put the Fed in a very tough spot. Hinting at more rate hikes for 2016 might have sounded smart, but with the recent market reaction, the Fed might actually have to change course.
After raising rates from zero by 25 basis points, the Fed might look confused if it suddenly reverses course and cuts rates back to that near-zero level. This was a big concern among Fed watchers, who questioned the Fed’s December rate hike at precisely the same time Japan and the European Union (EU) were cutting rates and hinting at more QE plans. This creates a big challenge for central banks in the weeks ahead, since global stock and bond markets do not seem ready, willing or able to handle a U.S. Fed that wants to raise interest rates.
It is not that the U.S. Fed made a bad decision, but rather, it is a Fed that has promised higher rates just when oil prices are collapsing, and China’s economy is apparently slowing down dramatically. So if you are Janet Yellen, what do you do? Do you reverse course and back off your plan to hike rates, or do you calmly say everything is fine and that global markets can handle the march toward higher rates? This is a tough spot for the Fed to deal with right now, and we all know that this sort of uncertainty has a way of rattling financial markets. We can only imagine what would happen if the Fed cut rates a mere month after raising rates by a quarter of a point.
This is the market we are in, but the headlines of stocks suffering their worst losses for a New Year ever, are not helping investor confidence at all. This has put a ton of pressure on the Federal Reserve, and we have already seen it sending out the troops (Fed Heads) to calm financial markets. The buzz this past week was that the lack of inflationary pressures and the not-so-great economic numbers we are seeing might have the Fed hold off on any more interest rate hikes. But the problem is that the Fed has already raised rates, and even though it was just once, the worry is that more are to follow. A change in policy might upset financial markets more than having the Fed “stay the course.”
Stocks are clearly oversold, as they say, and a bounce seems in the cards. As long as we see oil prices stop falling and China’s economy look stronger, then everything should be okay. We would also need to see earnings season turn out well, but by the looks of energy and bank earnings this past week, earnings season could be disappointing. That said, the Gorilla wishes each and all a relaxing weekend away from what has started off as a challenging year for the stock market. Bounces happen quickly, and we are definitely overdue for a bounce. Again, enjoy a wonderful winter weekend, and we will be back in action on Monday.
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