The reasons for investors to be pessimistic are beginning to pile up just as quickly as the market has been sliding down.
A once-pristine fundamental backdrop suddenly looks tarnished, as worries accelerate that economic growth may have peaked, political headwinds are forming, and rising interest rates will stand in the way of future fiscal stimulus from the Trump administration.
While stocks had been staging a mild relief rebound in November, Monday’s sharp decline shows that the market remains temperamental. All it took was a negative headline about iPhone demand for Apple and news about a lingering regulatory issue for Goldman Sachs to send Wall Street into another tailspin.
The market’s vulnerability has become a common theme among market pros warning their clients not to take too much risk in the current climate.
“Ongoing risks keep us cautious and we continue to recommend that investors pare back risk if their equity holdings are above longer-term strategic allocations,” senior strategists at Charles Schwab warned clients in a report Monday. “Economic and earnings growth rates may be peaking, while the labor market continues to tighten. This mix contributes to higher wage growth, possibly higher inflation and related uncertainty with regard to Fed policy.”
Those are but some of the risks on invevstors’ minds these days.
Talk around the Street has ranged from the dangers that wobbly fundamentals pose to the weak technical backdrop that includes a dangerous double-top chart formation in the S&P 500. Schwab’s team pointed out there remain reasons for hope, particularly from seasonal trends that back a strong November and a historical pattern behind positive results in the third year of presidential election cycles.
“But given the uncertainties that still exist and the potential slowdown in both earnings and economic growth, we continue to recommend a fairly cautious approach to investing, including discipline around diversification and rebalancing,” the paper, co-authored by Liz Ann Sonders, Brad Sorensen and Jeffrey Kleintop, advised.
The bear case
The factors lining up against the market are formidable: fears over growth in China and around the world, rising interest rates, the ongoing tariff battle between the U.S. and its trading partners, midterm election results that saw the Democrats take the House, slumping oil prices caused in part by a drop-off in demand and the likelihood that U.S. corporate profits, while stellar, are peaking and likely will taper off in 2019.
“Unlike 2016, there are no more tax cuts to salivate over and the deregulation momentum is going to now slow, or maybe stall, in the House,” David Rosenberg, chief economist and strategist at Gluskin Sheff, said in his daily note Monday. “Rare is the day when the stock market goes down in the lead-up to Thanksgiving – and if it does, that indeed will be a very bearish signal.”
November is generally a solid if unspectacular month for the markets, averaging a 0.9 percent gain over the past decade, ranking it fifth overall, according to FactSet. November, though, has not been negative since 2011, the longest winning streak for any month.
However, there are some cracks in market behavior.
Rosenberg pointed to rising trading volume amid a market decline Friday, which he said shows “that institutions are now more willing to sell on strength than buy the dips.”
On the more fundamental side of the ledger, a deceleration in China reflected in tumbling energy prices is just the latest sign of a global economy that is putting on the brakes. Meanwhile, the U.S. and China continue to apply duties to imports that, while not yet showing up in corporate earnings, are a concern into 2019 absent a thawing in tensions.
“So much of it is going to depend on the tariff stuff,” said JJ Kinahan, chief market strategist at TD Ameritrade. “The market hates uncertainty. That’s the biggest cause of uncertainty. You’ve got the election settled, hopefully you have that settled by the end of the month.”
The bull case
While optimism is on the ropes, the U.S. economy is far from being weak-kneed.
GDP growth continues to shine, and the fourth quarter is likely to be around the 3 percent level that would be consistent with the full year. The jobs machine continues to crank on all cylinders, with October alone adding 250,000 positions and wage growth that surpassed 3 percent year-over-year for the first time since the recovery began.
There’s also some trust that should things take a more pronounced downturn, the Federal Reserve will step in and halt or slow its interest rate increases.
However, there’s a good news-bad news scenario there as well.
“A pause in the tightening campaign might be cheered by markets, but only if economic growth remains healthy and inflation risk has ebbed,” the Schwab strategists said. “If the Fed is forced to lift its foot off the brake due to a sharper rolling over of growth — or in the face of rising inflation — markets would not likely take that as kindly.”
The election passing also is a cause for at least relief, as no post-midterm year has been negative since the end of World War II.
That doesn’t mean volatility can’t stick around. The Schwab note points out that the Black Monday 1987 crash was a year after the 1986 midterms.
The jobs picture also must be watched with caution. The 3.7 percent unemployment rate is well below what the Fed considers full employment, meaning that a turnaround in the jobs market seems only a matter of time.
“At the point the unemployment rate begins to tick higher again, it’s likely the countdown to the next recession will begin based on history,” the Schwab note said.
The brightest argument, then, may be that the market’s ups and downs are just the typical gyrations that nonetheless have been absent for much of the bull run that began in 2009. After all, even with Monday’s slide in stocks, the CBOE Volatility Index, which measures market fear, was barely above 20, or it’s long-term average.
“This is kind of where we are at right now,” Kinahan said. “There should be the possibility that sometimes stocks go down.”