Wall of worry for stocks just got higher

Patti Domm

Updated Mon, Jan 4, 2016, 8:04 AM

Markets are starting off the new year with a bang.

U.S. stocks plunged in a global equities sell off that started with a report showing a tenth month of decline in Chinese manufacturing. A weak U.S. ISM manufacturing report showing more contraction than expected Monday morning gave stocks another kick lower, with the Dow losing as much as 400 points.

Already there were hangovers from the old year — like concerns about oil oversupply, weak global growth and how frequently the Fed will raise rates. There's also the unexpected sharpening of tensions between Iran and Saudi Arabia over the weekend, following Saudi Arabia's execution of a Shia cleric.

Iranian protesters burned and attacked the Saudi embassy in Tehran, and Saudi Arabia cut off diplomatic relations with Iran. Oil rose as a result, with international benchmark, Brent crude, up 4.3 percent Monday.

"It's is a wake up call to the growing geopolitical and economic uncertainties around the globe," said Sam Stovall, chief equity strategist at S&P/Capital IQ.

Shanghai stocks sold off 7 percent before being halted.

"China I think is one of the risks to the global economy," said Russ Koesterich, global chief investment stratgist at BlackRock. "I don't think the sell off of the Chinese stock market is fundamental for U.S. investors but it clearly affects sentiment."

Koesterich said some of the selling in Shanghai was technical, as restrictions on selling and other measures that were put in place during the summer selloff were being lifted.

He expects more China related sell offs in coming years. "It's one of the things that's going to erupt over the next couple of years as teh economy transitions. It's going to be more a source of volatility than one that mitigates it," he said.

Traders traditionally look to the first trading days of the year for clues about monthly and annual performance. There's the old Wall Street adage - 'so goes January, so goes the year.'

But Stovall said January has often been a rough month for stocks, and stocks rarely just move higher during the year. The S&P 500 has reached a lower level than where it started out the year 87 percent of the time since 1945, he said.

"One-third of all year-to-date lows were established in January," he said, noting the next highest month was October at 13 percent.

Stocks closed out a dramatic but ultimately, unsatisfying 2015, with the market selling off into the close on its final trading day, turning in a sluggish and mixed performance for the year.

The S&P 500 (INDEX: .SPX) and Dow (Dow Jones Global Indexes: .DJI) had their worst years since 2008. The S&P closed at 2,043, a decline of 0.7 percent, a second negative year since 2008, following on the even slimmer 0.003 percent decline of 2011. The Dow was down 2.2 percent at 17,425, but the Nasdaq (NASDAQ: .IXIC) was a bright spot, closing up 5.7 percent at 5007. A CNBC survey of 14 Wall Street strategists shows they expect relatively modest single-digit gains in 2016, with the S&P 500 expected to rise to an average 2,213.

Treasury yields were lower Monday as investors sought safety during the equities rout.

There's plenty for the bond market to consider this week including the Monday release of disappointing ISM manufacturing data, which came in at 48.2. There are also Fed meeting minutes and trade data on Wednesday, and the December employment report Friday. There are also about a half-dozen Fed speeches.

"It's the typical beginning of the month, reports coming in and people looking for a fresh start on a new year. January typically long term has been a relatively strong month, but in the more recent years, the returns haven't been that great," said Paul Hickey, co-founder of Bespoke. "Last year, we (stocks) were down 3 percent, and the year before down 3.5 percent, and 2013, up 5 percent. The last two years have been really weak so I don't think people are looking for too much."

Then there's the unexpected factors, like the events that notched up tensions between Saudi Arabia and Iran.

Oil was one of the biggest factors impeding stock market gains in 2015, leaving the S&P 500 flat and lower for the year. The outlook for oil has been for another move lower, due to global oversupply, but oil futures were rising since they opened Sunday night on the Mideast tension.

"All of this pits the Gulf region's largest producers against each other to the point of conflict," said John Kilduff of Again Capital. "The stakes are, obviously, tremendous. A quick climb down (in oil prices) looked likely until the Saudi move. This is potentially a very largere-inflation of oil's security price premium."

Economists expect to see 200,000 nonfarm payrolls Friday, just below the 211,000 jobs in November, and an unemployment rate unchanged at 5 percent. Because of a weak comparison, economists expect that average hourly earnings could increase by as much 2.8 percent year over year, higher than the recent trend.

"I think the theme we're going to see in the first half of the year is that the labor market is still doing reasonably well but other parts of the economy are more mixed. We should have good construction data, decent vehicle sales but you're going to have weakness in net exports and weakness in manufacturing," said Deutsche Bank chief U.S. economist Joseph LaVorgna. "The question is how much of that spills into the nonmanufacturing sector."

LaVorgna expects growth to pick up to 2 percent in 2016 after a weaker fourth-quarter pace, running at about 1.5 percent.

The stock market's gains were repeatedly choked by oil's greater-than-expected decline in 2015. Oil's stronghold on other markets foiled the expectations of stock strategists that had forecast the S&P would rise to about 2,200 in 2015, according to an earlier CNBC strategist survey. The S&P 500 is now 4.3 percent below its all-time high of 2,134 reached in May.

The dollar (Intercontinental Exchange US: .DXY) also was a culprit, biting into overseas profits of U.S. multinationals and hurting commodities and emerging markets. The dollar index was up 9 percent in 2015, but analysts expect the impact on corporate earnings to lessen in 2016.

"For next year our (S&P) target is 2,200 for year-end 2016. We're calling for modest gains," said Jill Carey Hall, equity strategist at Bank of America Merrill Lynch. "We're forecasting earnings growth of 5 percent. That's a pickup from flattish earnings growth this year. … Earnings for the multinationals should see fewer headwinds."

Scott Wren, senior global equity strategist with Wells Fargo Investment Institute, said he expects the market to continue moving higher in 2016 even after a flat year. "Our analysis has shown that the market should finish higher. We wouldn't be surprised to see fairly quickly in the new year a new high in the S&P," he said. He sees the nearly 7-year-old bull market as being in the equivalent of a "seventh inning" of the nine, played in baseball.

"We're still leaning toward sectors that are more sensitive to the recovery here and aboard. Consumer discretionary, technology and we continue to like industrials. What we don't want clients doing is things like getting defensive in utilities and staples," said Wren. He expects the S&P to reach 2,280 at year-end 2016.

Traders had been watching the S&P into the year end, with an eye on 2011, the last flat year. "If the 2011 playbook is correct, we should have a strong first quarter. The market had a good move," said Scott Redler, partner with T3Live.com. The S&P was up 13 percent in 2012.

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