What could bring US stocks crashing down to earth?

What could bring US stocks crashing down to earth?

Amid recent domestic and international developments, the US stock market’s relentless drive higher has caused some nail-biting on Wall Street that the rally is about to end. 

With the benchmark S&P 500 .SPX rising nearly 29%, stocks ended 2019 with their best year since 2013. Yet some investors are increasingly nervous that the year-end “melt-up” in shares will turn into a scary melt-down.

Here are the principal risks preoccupying Wall Street as 2020 gets under way:

Corporate growth

The stock market’s impressive 2019 gains came despite an underwhelming year for corporate profit growth, but performance may suffer if earnings lag in 2020.

Fourth-quarter reporting season is almost underway and results are expected to be anemic, with S&P 500 earnings seen down 0.3%, according to Refinitiv data.

While some analysts expect S&P 500 earnings to rise 9.7% in 2020, others are skeptical. Indeed, data on Friday showed the US manufacturing sector contracted in December by the largest amount in more than a decade.

US-China

An initial US-China trade agreement provided a much needed year-end boost for stocks, but any hitch in the Phase 1 deal between the world’s two largest economies could rattle markets.

“The rivalry between the US and China hasn’t gone away,” Mark Haefele, chief investment officer at UBS Global Wealth Management, told Reuters. “Investors will be alert for any sign that tensions are re-emerging, or either side is dissatisfied with the implementation of the Phase 1 agreement.”

The Fed

Others point to the policy whims of the Federal Reserve as a principal factor. According to analysts at Bianco Research, when the Fed injects money into the economy, funds generally flow to the best-returning market, prompting the question of what happens when the Fed ends T-bill purchases and repo support. 

In October, the Fed declared that it would start buying about $60 billion per month in Treasury bills to ensure “ample reserves” in the banking system, a program that would continue at least until the second quarter of 2020. The Fed would also continue to support short-term lending markets by offering daily operations in the market for repurchase agreements, or repo.

Domestic politics

Markets will increasingly focus on the US  presidential race as Democratic primaries get underway next month and the general election in November moves closer.

Several prominent investors have warned of steep stock declines should a progressive candidate secure the Democratic nomination and go on to win the White House, particularly if Democrats sweep both houses of Congress, paving the way for major policy overhauls.

Nevertheless, investors currently see little market risk from the impeachment of Trump, a position that could potentially change if Republican senators begin defecting against him in significant numbers during the trial.

As the market soared in 2019, so did investor bullishness about equities despite the potential danger signs of rising valuations.

According to the AAII Investor Sentiment Survey, bullish sentiment grew in the Dec. 19 reading to its highest level since October 2018, shortly before the market endured a year-end swoon. 

Geopolitical risks

Yet stocks were hit Friday, with investors moved into safe-haven assets after a US  air strike in Baghdad killed Iran’s most prominent military commander.

“Geopolitics has come back to the table and this is something that could have major cross asset implications,” Salman Ahmed, chief investment strategist at Lombard Odier Investment Management in London, told Reuters.

Oil prices also spiked at the news and a surge in the commodity remains a concern. Beyond flaring Middle East tensions, however, Mark Haefele commented to Reuters that risks regarding Britain’s exit from the European Union have “abated, though not quite disappeared, and while his “base case is that a hard Brexit is avoided, this will likely remain a concern for investors in coming months.”

2020-01-13T14:50:08+00:00

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Paul Imison
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