The Upcoming Correction of 2016

After a rough start to 2016, it seems like markets worldwide have finally started to stabilize. After dropping almost 10% during the first few weeks, the S&P 500 has staged a great recovery and is nearing a breakeven for the year.

While the recovery has been impressive, I think investors should still stay cautious as I believe the recent surge is nothing more than a bear market rally that is setting the stock market up for a bigger crash. Hence, I would advise investors to follow the long-short strategy and not have a long only portfolio.

Over the last few months, my long-short portfolio ideas have widely outperformed the market as my long ideas like Spirit Airlines (SAVE), Macy’s (M), Oaktree Capital (OAK), JetBlue (JBLU) etc., are up considerably, whereas my best short ideas like Wayfair (W), Mobileye (MBLY), GoPro (GPRO), Fitbit (FIT), SolarCity (SCTY), etc. have plunged.

Why the coming crash will be worse

Given the falling corporate earnings, I believe a strong correction in the market is long overdue.
Corporate earnings have shrunk for three consecutive quarters, and with the strength of the U.S. dollar increasing, earnings will continue taking a hit. In addition, corporate revenues have fallen for four successive quarters, which is why I think the market will correct more severely again in 2016.

Although many large companies have boosted their EPS by buying back shares, I don’t think this strategy will continue to keep the market up. I am not a fan of stock buybacks as they don’t generate any new revenue streams. In 2015, it was estimated that companies spent nearly $1 trillion on buybacks and dividends.

Given the increasing amount of money spent on buybacks over the last few quarters, and the increasing strength of the dollar, I expect corporate earnings to continue shrinking. The falling earnings and revenue will also likely cause another, more severe correction in 2016, which is why I think investors should have a hedged portfolio.

Conclusion

The S&P 500 has staged a stunning recovery over the last few days, and will likely cross the 2,000 mark in the coming days. However, I think investors should be cautious about the market as I expect a much more severe correction in 2016. Falling corporate earnings and revenue will put downward pressure on the market. Hence, I think investors should have a hedged portfolio that has a net short position in order to profit from the upcoming correction.
Published on Mar 3, 2016
By Ayush Singh

Copyrighted 2016. Content published with author's permission.

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