The stock market rally is winding down for these reasons
2 months ago admin2 Comments Off on The stock market rally is winding down for these reasons
This year has been a rough ride for stock investors. After a nearly perfect 10-year bull market run, stocks are basically flat so far this year and are much more volatile. For investors who have become accustomed to steady gains, seeing the S&P 500 index move more than 1% in a day 31 times so far this year is quite unsettling.
It’s impossible to know for certain, but it feels to us that the great bull-market party is winding down. While 2017 may still provide positive returns in the stock market and a bear market may still be a ways off, it seems to us that the great returns of the past decade are now a thing of the past. The key change is from certain growth to certain uncertainty.
Is the world economy really growing?
Globally synchronized growth has been one of the key drivers of the bull market. But now that growth is in question. Early indicators like payrolls, wages, consumption, and output point to a drag on economies around the world. UBS says that its data shows that growth in developed markets (excluding the US) “is falling off a cliff” in the first quarter of 2018. While the analysts provide plenty of caveats that their data could be wrong, the possibility they could be right is a big concern.
Cheap money is ending
Gone are the days of cheap and easy money from the central banks. Globally, we have passed the peak of central-bank largesse as the central banks either begin reducing the purchase of assets or sell them. In the US, the Federal Reserve is finally raising rates and starting to unwind its balance sheet. That puts pressure on all kinds of companies that need money. It also raises the question of whether the Fed will be able to save the economy again next time we hit a rough patch.
Too much tech
Big tech stocks have been strong performers, especially in the last couple of years. But now governments are investigating data practices and threatening regulation. And Wall Street is concerned about lackluster consumer interest in perhaps the most important product to the market, the Apple iPhone. So far in 2018, the 10 largest market-cap companies (including Apple, Google, Microsoft, Amazon, and Facebook) have contributed almost half of the gains of the S&P 500; much more than the one third they contributed in 2017. With that kind of concentration, can the market still go up as a whole if the tech sector stops going up?
Interest rates are rising
US Treasuries recently topped 3% for the first time since 2014. This has two big effects. First, investors will now be more likely to move money into fixed income from stocks to capture the improving risk/reward. Second, companies will now have increasing interest expense that could reduce profits. Both of these effects could be negatives for stocks.
Trump’s tax benefit is done and dusted
The upside of the recent US tax reduction is now baked in, meaning that investors now know how much corporate profits will improve. Now, the talk is less about corporate tax benefits and more about government deficits. US debt has grown to $10 trillion from $6 trillion in 2000. And despite a strong economy that would normally encourage policy makers to reduce debt, the government is now adding up to $1 trillion annually to the deficit as a result of the recent Tax Cut and Job Creation bill. While low rates have kept the government-debt payments low, rising rates will create a bigger, long-term burden for the US economy.
Speaking of Trump…
Investors seem to be relatively immune to the volatility of the White House with one exception: trade. The threat or pursuit (or whatever the current strategy is) of a trade war is highly unsettling and adds big uncertainties to any industry or company that does business overseas. Beyond trade, there are plenty of other destabilizing risks including dismantling NAFTA, disrupting European relationships by pulling out of the Iran deal, and military confrontations in the Middle East or Asia. Any and all of these could have a big impact on the market.
The recession risk is building
Everyone knows that the current economic expansion will end and that we will endure another recession at some point. That’s just the way economies work. But now it seems that many people are starting to wonder if the recession will start sooner rather than later. Predicting a recession is nearly impossible; in fact, the start of a recession is only determined in hindsight. But it seems that the general consensus is that we’ll enter a recession sometime in the next two years. That means that investors are starting to question longer-term forecasts and wonder if earnings estimates are too high because a recession is on the horizon.
All of these uncertainties increase risk. And when there is too much risk, the investors who try to time the market get out.
It’s too soon to know if “last call” has already been called at this party or if we have time for one more round. But, to us, it seems like the party is winding down and it’s time to figure out what to do when the music stops. As always, we believe in a well diversified portfolio across asset classes to take advantage of the best opportunities in all market environments. Given all of the uncertainties ahead, this could be a very good time to stop and assess your investment strategy carefully—or risk a bad hangover.