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Stocks may be setting up for negative year

Patti Domm

Stocks are expected to test the lows of the year in the near future and could be setting up for the first really negative year since 2008.

Wall Street's consensus view remains that the market will close higher in 2015, expected to bounce after testing the year lows, but some strategists say the odds are growing that the market will end the year with losses. The S&P 500 (INDEX: .SPX) last closed lower on the year in 2011 when it was basically flat, less than a 10th of a point lower. The last time it was negative before that was when it declined by 38 percent in 2008.

Goldman Sachs Tuesday became one of the first firms to officially forecast a negative year, cutting its year end estimate for the S&P 500 to 2000, from 2100. It cited a slower pace of activity in China and the drop in oil prices, which has slammed earnings.

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Stock futures were slightly higher Tuesday, as commodities, like copper and oil, firmed. The S&P 500 Monday fell 49 points or 2.6 percent to 1,881, and the Dow (Dow Jones Global Indexes: .DJI) was down 312 points to 16,001.

Even with Tuesday's bounce, strategists say the S&P is likely to take aim at 1,867, the low set Aug. 24, and some see it continuing to move lower in an environment of uncertainty about China, the global economy, rising interest rates and the commodities meltdown. Add to that the steep decline in market leader biotech, which took another hit Monday after congressional Democrats pushed for a hearing on Valeant's (Toronto Stock Exchange: VRX-CA) pricing practices. Valeant lost 16 percent and the IBB iShares Nasdaq Biotech ETF (NASDAQ: IBB) fell 6.3 percent Monday, giving it a 14 percent decline in the past week. The ETF was slightly higher ahead of Tuesday's open.

"If we break that August low, what I think you do is everybody brings down their (S&P 500) targets, and that will bring capitulation," said James Paulsen, chief investment strategist at Wells Capital Management. "And that kind of thing will bring a bottom. If we rebound, nobody's going to bring down their target. If that happens, it does prolong this because people will think we'll rally to year end, and I think we need a bigger capitulation and better value than we have now."

Sam Stovall, chief equity strategist at S&P/Capital IQ said the market could very well end the year lower, depending on how steep the correction becomes. In 2011, the market was off more than 19 percent peak to trough, but when it bottomed on Oct. 3, it was down 12.6 percent year to date. The S&P 500 was down 8.6 percent year to date as of Monday's close.

"October is the favorite month for corrections and bear markets to end," said Stovall. Since World War II, the fourth quarter has averaged a gain of 3.8 percent as stocks benefit from seasonal gains. "We're going to need a very strong recovery to even get anywhere close to the surface, to peek our heads above water," he said.

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Andrew Burkly, head of institutional portfolio strategy at Oppenheimer, said he does expect the market to be more similar to its performance in 2011, with the market bouncing after it finds a new floor, but ending the year slightly higher instead of flat. Burkly said the S&P 500 could break through 1867 and retest the lows from last October, of 1820 in the next several weeks, before heading higher.

"I think we're getting pretty close. We always felt like this was setting up as a classic bottoming pattern. August 24 was climactic and the bounce into old resistance really didn't last," said Burkly. "The idea is we don't want it to be as climactic as it was in August. That would be a better sign."

FundStrat Global Advisors founder Thomas Lee said he's been speaking with active fundamental managers, and they are very wary of the market. "I don't think anybody is really doing anything in the markets right now. They've stepped away because the market has scared them so much, and the second thing is that a lot of people think we're going to have a huge crash," he said.

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Lee said he thinks the market will ultimately rebound and could close higher on the year, and the fact managers are so bearish is positive to him. "As ironic as it sounds, I actually feel better. I think the list of worries is so great that people decided instead of having a belief of how it resolves, they'd rather wait for it to resolve before they decide what to do," he said. "Everybody is letting everybody else give them conviction about what to do. That's actually constructive."

Jack Ablin, CIO of BMO Private Bank, said he's been cautious for a while and began raising cash in August. He had expected the S&P 500 to end the year in a range between a slight 5 percent gain to a 10 percent loss.

"We had a negative skew…. The offset is there's a lot of skepticism around. In a world where the stock market is at the intersection of reality and expectations, it's good to know expectations are very low right now," he said. Ablin said the market volatility could be greater ahead of the end of the quarter.

"The sell in May go away doesn't go away until Nov. 1," he said, referring to the old market adage that the summer is the worst time for stocks and the best is November through April.

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Paulsen said he sees the market continuing to seek a floor. "My feeling has been that we're probably going to break those lows and break 18,800 and find a bottom there somewhere. I don't know if that's now or later," he said. "To me, this is more about the market finding a better valuation and sentiment being checked and people getting over the initial shock of rates going up."

For Tuesday, traders will continue to watch the biotechs, which have been a point of pain for some investors. Burkly said the sell-off in biotech comes after the growth momentum trade topped, and now investors will have to watch the fundamental story more closely. "What it means is you have to be more selective. It's not an ETF trade anymore. Now, I think there's going to be some differentiation, given how it's in the spotlight of these politicians and legislators."

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Burkly said the steep drop of commodities firm Glencore's stock on fears about its debt is the type of event that the markets have been waiting for. "I felt like before you got a bottoming in the commodities market, you were going to get some credit situations," he said. He said there could be some negative credit events in the industry that would mark a capitulation though he was not specifically commenting on Glencore. Some Glencore debt, rated investment grade, trades with double-digit yields.

Economic data Tuesday includes S&P/Case-Shiller home price data at 9 a.m. ET and September consumer confidence at 10 a.m.

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