Although the S&P 500 Index (SPX) is trading near all-time highs, a number of investment managers believe that four key negative factors dampen the prospects for additional gains through the end of 2019. They worry that we may be set for a replay of the situation almost exactly a year ago when the S&P 500 peaked in late September, then plunged by almost 20% during the next three months.
These four negative factors are: the protracted U.S.-China trade war, continued deterioration in the outlook for corporate profits, weakening economic data, especially in manufacturing, and plunging bond yields, according to a detailed report in The Wall Street Journal as outlined below. Oliver Jones, senior markets economist at Capital Economics, expects that the S&P 500 will endure a “sizable fall” before 2019 is over. Jonathan Golub, the chief U.S. equity strategist at Credit Suisse, told the Journal, “I’ve been extremely bullish the last six years, and this is the most cautious I’ve been in quite a long time.”
- Four key negatives point to a stock market decline ahead.
- The escalating U.S.-China trade war is one big negative.
- Two other negatives are declining earnings and manufacturing activity.
- The last is falling interest rates, suggesting rising recessionary risks.
Significance For Investors
“You don’t have to believe a recession is on the corner to believe earnings estimates have to come down quite a bit more,” Jones indicated to the Journal. He is among those who believe that consensus estimates of corporate earnings growth in 2020 are too optimistic. As for Golub, he elaborated, “[It’s] not that I’m calling for the market to correct in a major way, and not that I’m calling for a recession, but I do see a deceleration in the underlying data that I think is an impediment to the market going forward."
“The trade overhang is such a big factor,” notes Rebecca Felton, senior portfolio manager and chief risk officer at RiverFront Investment Group. Indeed, according to a timeline of the late 2018 market tumble compiled by FactSet Research Systems, a threat by President Trump to impose new tariffs on imports from China was a key early event. Meanwhile, Sept. 2019 began with a new round of tariffs actually taking effect.
Regarding corporate profits, they slid sharply last fall, with weak reports from leading industrial companies Caterpillar Inc. (CAT) and 3M Co. (MMM) being major catalysts for a stock market selloff. Today, S&P 500 earnings are enduring their longest period of decline since 2016, per data compiled by FactSet.
With respect to the U.S. industrial sector, the ISM Manufacturing Index declined in August for the first time in three years. In the latter months of 2018, falling manufacturing activity was being registered in Europe and Asia, per the Journal. The August reading of 49.1 was the lowest since Jan. 2016, below the cutoff value of 50 that usually indicates a stable economy, a column in the Financial Times notes.
Finally, the yield on the benchmark 10-Year U.S. Treasury Note has crashed from about 3.2% on Oct. 1, 2018 to as low as 1.4% in recent weeks, per CNBC. Falling bond yields can indicate rising expectations of an economic contraction ahead. Indeed, the Federal Reserve has reversed course from raising to lowering the federal funds rate in an attempt to prop up the economy, based its own concerns about rising recessionary risks.
“In an earnings recession, companies attempt to cut bloated costs,” warns Michael Wilson, chief US equity strategist at Morgan Stanley, as quoted in the FT column “But they simply can’t cut fast enough as demand is also decelerating,” he added. The early targets of such cost cutting tend to include capital investment, and that will add to earnings declines in sectors such as industrials and materials, and perhaps in information technology.
A contrasting view is voiced by Dev Kantesaria, a portfolio manager and founder of equity hedge fund Valley Forge Capital. “The lower interest rates are, the more exciting it becomes to own equities in the long term," he told the Journal. He added, “The trade turmoil continues, but the average S&P 500 company is very attractive at these valuations.”