DCJ Market Commentary

2015 Market Review and Outlook for 2016

As 2015 came to a close, my concerns related to the health of the equity markets (as pointed out in our last three market updates) have so far been realized. While I will be as brief and succinct as possible, it is my mission to inform you about some of the more important developments as we view them both in the equity markets and overall U.S. economy. As in past market updates, I will use the S&P 500 index as a proxy instrument for our analysis of U.S. equities. This review and outlook will focus on the following areas that I believe can have an impact your wealth today and in the future:

Technical Equity Market Analysis

  • 2015 Midyear Summary: Our most recent alert to increased risks in equity investing
  • When the Correction Came a Calling
  • When the crowd runs from the many, the few will rise to the stars, won’t they?

Fundamental Outliers That Can Burst an Economic Bubble

  • Not planes, not trains, it’s about automobiles!
  • Earnings growth? Are we asleep at the wheel?
  • Historical profit margins and where did they lead?
  • China, the Canary in the Coal Mine?

While I am an investment manager and not a psychic, I will share some conclusions that I think you will find to be reasonable thoughts on the direction of equities for 2016.

Technical Equity Market Analysis

2015 Midyear Update Summary: Our most recent alert to increased risks in equity investing

We penned the following points in our Midyear update in early July, last summer: “At this time, the following chart, blown up to show the current area, depicts a broadening possible to after attempting multiple pushes into the up sloping blue line. On a weekly basis, we have not taken out any bottoms to speak of, however, given the area is a possible reversal point and the fact that we are seeing sellers show up (causing the red bars down) gives us significant pause, as there has not been an index (or market) correction of more than 10% in about 3 years. While this point is unusual, it does not mean an imminent bear market for the index.”

Midyear 2015-4 S&P - Copy

Our conclusion was this:

While this market appears to be setting up for a correction, it might just keep going higher. I hope that we have made very clear that the area we have been in for several months is a critical area for the market to make a decision one way or the other. The follow through that we see in the coming days, up or down, we think will provide the answers needed in order to attempt to increase gains and limit downside risk in your managed accounts. The media will be sure to tell us the causes why, albeit most likely after the moves have occurred.”

When the Correction Came a Calling

Shortly after the midyear update was distributed, I began to see more technical logic that increased my conviction to not add additional capital to equity positions. Subsequently, the S&P 500 had a 10%+ correction.

2016 outlook S&P chart

As can be seen above, the S&P 500 Index makes a low in August, pushes back up near the all-time high to where I have marked “lower high” and then falls, it pushes up one more time but fails to push through the all-time high again. I term this failure as a “rejection,” and then on January 4th, 2016 it makes a new lower low. This is indicative of a weak market. While it certainly can go back up and take out the all-time high, it is now clear to me there are sellers in the area.  “Sellers in the area” could be taken to mean that large institutions (investors and traders), as well as individuals (investors and traders), see this area as a place to get out of the market or to invest in some form of investment that goes up when equities go down.

However, if the market strengthens here, makes higher highs and higher lows, makes a new all-time high, and does not fail there, I would then expect higher prices going forward. For this to occur, unlike the majority of 2015, we would need to see a lot more than a hand full of stocks making new highs. Either it broadens out with small, mid, and large cap stocks all performing better or we can expect lower prices. For now, I am not convinced. Should I see technical merit warrant it, then and only then would I risk more of your hard earned capital. This is our policy and this is our process.

When the crowd runs from the many, the few will rise to the stars, won’t they?

On July 26th, 2015, the Wall Street Journal cited the fact that six stocks, had accounted for more than all of the $199 billion in market-capitalization gains in the S&P 500. At the time the story went to press, the S&P 500 was up 1% year to date.  This shift from many stocks performing well down to a handful of the 500 issues that comprise the index has been quietly happening but with little fanfare.  Our work picked this up back in early 2014. While it was unsettling, until recently, though weakening, the S&P 500 index continued to print new highs.  The close of 2015 left the S&P 500 index down about 1% for the year.  The shift from many to a few stocks moving higher in 2015 can be seen in the chart below sourced by Morningstar.

Fund category 2016

While this chart does not include the S&P 500 index, it is quite a good example of how large stocks generally made money while other equity asset classes lost money.

Not by coincidence, this kind of price action in the S&P 500 index similarly occurred in the late 1990’s before the bear market that started with the S&P 500 index high around March of 2000. On yet another occasion, similar price action occurred near the 2007 market peak.  In both cases, it took some time before investors and market pundits became aware that a bear market had already begun. In both cases, the S&P 500 fell over 50% from peak to trough.  Markets that may be rolling over never look quite the same each time. Markets rhyme.

Fundamental Outliers That Can Burst an Economic Bubble 

Not Planes, Not Trains, It’s all about Automobiles!

As my work in discerning what is happening under our economic hood, my eyes are cast onto hundreds of economic data points throughout a given year. This particular bit of data below struck a chord in my throat at how similar the auto industry looks in terms of bubbles by contrast to housing prices, easy money, and subprime buyers in the most recent decade.

Total auto lending in the U.S. is now more than one trillion dollars. According to the U.S. Federal Reserve (Consumer Credit September 2015), through the 3rd quarter of 2015, outstanding motor vehicle loans are $1,029.6 trillion dollars. This is up from $713.5 billion dollars in 2010 and is on track to go over $1.287 trillion by 12/31/2015.  That would be an increase of 80.35% over the last five years. Just let that sink in for a second. That is $1,287,000,000,000 in auto loans.   Additionally, in 2010, those with subprime credit accounted for some 10-20% of new car loans. By some estimates, that number now has eclipsed 30%.  When easy money is available it will find its way to the least worthy borrower. Does this sound familiar?

While the auto industry is not the largest component of U.S. industrial output, it has been a substantial piece of industrial and credit growth during the current economic cycle. The financial facts are that whether it is a home, a farm, a car, or a student loan, the easier the lending standards become, eventually, increasing credit losses will occur.

Experts of credit cycles know that when credit losses expand, repossessions explode, the repossessed assets (collateral for the loans), are sold at fire sale values thereby collapsing the respective markets.

Earnings growth? Are we asleep at the Wheel?

The historical earnings growth for the S&P 500, through the 3rd quarter, 2015, has been consistently falling over the course of the last four quarters and is now in negative territory.   While no one piece of evidence should ever drive an investment decision, the trend for earnings growth is disconcerting.  While equity prices have risen over the last four years, according to Factset Data, earnings growth has been going in the opposite direction.

historical earnings 2016

Historical profit margins and where did they lead?

As pointed out below, when the S&P 500 net profit margins peaked and then declined by 60%, except in 1985, it coincided with or predicted a recession. While net profit margins have not declined by 60% thus far in this economic cycle, they have been contracting rapidly over the last several months.

While recessions are defined usually after the fact, the above chart is but one more piece of the puzzle that gives us pause in the context of price action in equities.

China the Canary?

As of this morning, 1/5/2016, China’s equity markets are off to a dismal beginning for the year and their main index measure was off over 7% until the Chinese Government intervened. At one point yesterday, the Dow Jones industrials were down more than 400 points to start the year. There was a direct correlation between the two markets yesterday. Had the Dow closed 400 points down, it would have been the worst start for the index in 84 years.  It closed higher than the lows of the day, although it was off over -1.58% on the day to kick off the New Year.

Cheap money strategies in China, the U.S., and many world economies have been used with reckless abandon and some have done so for many years. The outcome as I pointed out in the section on automobiles will likely produce negative consequences in the coming months and years as printing money causes, among other things, an inefficient use of resources.

What we are seeing in China is an example of the negative consequences of cheap money policies causing a misallocation of resources. The bubble fills, the bubble slowly leaks (inflation that eats away your purchasing power), or it bursts all at once bringing down investment valuations with it. The leaky balloon may be the most dangerous as it silently chips away at purchasing power with most of us not understanding what is occurring.  If Chinese indexes continue to make lower lows, I would expect U.S. equities to follow.

Reasonable Conclusions and Possible Opportunities

The evidence suggests both fundamentally and technically that bull case for equities will likely be challenged for 2016. Many investment research firms and advisories are on the bandwagon for a down year in stocks.  While I would likely be on board for that position, I see some possible opportunities that we intend to take advantage of should they present themselves in 2016.  Think, “buy low, sell high” as I spell out what I think could be particular

  • Oil the commodity and those that dig it up

Like it or not, while most of us are alive, oil is in our future. The oil industry has really coined the phrase “boom and bust”! We are now in the “bust” period. What I am seeing is that most stocks related to the oil and gas industry continue to get cheaper by day.  There are brief strong rallies higher only to be followed by new lows.  The whole category continues in a steep decline.

At some point, some of the highly indebted firms will literally be gone. Others, however, will flourish. This is a situation that may or may not be an opportunity this year.  It is on our radar and with strict buy and sell criteria, we will seek to take advantage of specific individual stocks and/or exchange traded funds.  At the moment, many catch my eye; none appear to have good reward to risk characteristics. We are patient, process driven, stewards of your capital.  There will be a time.

  • Hello Argentina!

As South America succumbs to the fate of political leftist progress, many of the economies there have become places the typical American would not want to live. While this is a broad brush, less a couple of small countries, it is all about government intervention and redistribution of wealth.  Most national governments have managed to nationalize (read: confiscate) private industries over the years and effectively wipe out capitalism.

For the past 12 years Ms. Fernandez and her husband Nestor Kirchner (who died in 2010), have had overwhelming governmental control of the Argentinian economy. It has been said that they were corrupt and were aligned with regional authoritarian regimes.  They undermined the media, the judiciary, and the federal banking system.  In effect, they established authoritarian rule. A new president, Maurico Macri, was elected late last year.  It is his intent to restore a more capitalistic free market structure throughout the legislature, judiciary, and appears to be completely

pro private business. While this is no small task, free markets work. As Mr. Macri seeks to implement this free market structure, yours truly will be watching closely the exchanged traded fund that largely tracks the Argentinian equity market.  Should I see an opportunity that fits our investment criteria, we will pursue investing there.

  • No one knows for sure

Within all of our portfolio strategies there is a process that drives our decisions as most of you already know. Well, at the moment, all of our equity portfolios are underweight equities and if you have read this far, you know why. However, no one knows for sure what the equity markets will do this year.  Our commitment has not changed. We are biased toward managing risk first and then attempting to create return on your investment capital.  When and if we see opportunities with measurable and tolerable reward to risk, we will seek to act on it.  If not, we will not invest.

And last, as always, we are humbled and grateful to work with you, and we stand ready to help you whenever you need us.


Warmest regards,

David Carl Jones


Office: 901-755-9797

3011 Centre Oak Way, Suite 101, Germantown, TN, 38138



The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

Investing involves risk including the loss of principal.

All indices are unmanaged and cannot be invested into directly. Unmanaged index returns do not reflect fees, expenses, or sales charges. Index performance is not indicative of the performance of any investment. Past performance is no guarantee of future results.