Today marks the tenth trading day in 2016 that the S&P/TSX composite index is lower. Volatility remains elevated and much more destructive on the downside. Every rally has been used as a selling opportunity and has failed to last more than a day.
The price of oil is leading the equity markets lower, and we have yet to see any stabilization in prices with supplies from Iran expected to flood an already oversupplied market. Wednesday, after the market close, the American Petroleum Institute's weekly oil inventory report will be released, which may create further erratic moves in the commodity price.
While we are in the midst of the fourth-quarter earnings season, concerns surrounding the global economy are overshadowing earnings.
To give a sense of the value destruction, the TSX index has closed higher just three days this year, rising 55 points, 60 points, and 166 points. However, there have been four days when the TSX index has fallen over 200 points and seven days when the index has experienced triple-digit losses.
Today, the S&P 500 index broke down below the August low and the Dow Jones Industrial Average is less than 50 points from breaking below its August low. Key technical support levels are being taken out – not a good sign for the markets.
Yet, capitulation is not apparent.
The VIX Index is not spiking back to the levels that we experienced in the summer. On Aug. 24, the VIX index spiked over 40. Today, we are up 2 points to over 28.
Small caps are taking the brunt of the fall. The S&P/TSX SmallCap index is down 15 per cent year-to-date, while the large cap index, the S&P/TSX 60 index, is down 10 per cent year-to-date. The S&P/TSX Venture composite index is not down as steeply as the SmallCap index, declining 10 per cent year-to-date.
On a valuation basis, the TSX index is trading below its historical averages. The index is trading at a price-to-earnings (p/e) multiple of 13.8 times, the 2016 consensus estimate. This is below its three-year average of 16.2 times, and both the five-year and ten-year averages, which are each at 15.3 times.
So what's the downside?
In terms of downside risk, the lowest p/e multiple over the past three years is just over 13 times, and the p/e multiple troughed at just over 12 times over the past five years. Based on the current consensus earnings estimate, if the multiple were to contract to 13 times, the S&P/TSX composite index could fall to around 11,000, or down another 5 per cent. If the multiple were to contract to 12 times, the low over the past five years, the TSX index could fall to 10,200, or 12 per cent.
Markets often fall faster than they climb higher. The trend is your friend as they say, and for now, negative market sentiment with falling oil prices and global economic concerns, are sustaining the market downtrend.