Market sentiment appears to have shifted abruptly in 2018. For the first part of the year Wall Street seemed quite optimistic following the corporate tax cuts in late 2018 which translated into strong earnings reports and solid economic growth. Yet in the second half of the year investor attitudes appear to have changed as the focus has shifted to potential risks on the horizon rather than hard data.
There are a number of risks that seem to be influencing investor behavior recently. These include:
- Short-term interest rates are increasing. This has stoked fear that the debt cycle may come to an end as higher interest costs may reduce the amount of consumer spending. While household debt is at a historical high the level of household debt payments as a percentage of household income remains fairly low and retail spending has been strong in recent months.
- Global trade disruptions may negatively impact global economic growth. Anecdotal evidence shows that business leaders are very concerned about the impact that US tariffs, retaliatory measures, and failed Brexit negotiations may have on the global business environment. However, both US imports and exports have increased over the past year showing that overall trade activity has continued to increase.
- Economists worry that global economic growth may be on the decline. The Euro-zone has reported weaker economic growth and China’s economic growth numbers are being viewed with increased skepticism. In addition, the falling price of oil and other key commodities have some speculating that weak commodity demand could be a sign of slowing economic growth, especially in emerging markets. Yet most large economies, including the US, continue to report positive economic growth.
- The corporate earnings growth rate is expected to decrease in 2019 as the impact of the corporate tax cuts fall out of year-over-year comparisons. Yet corporate earnings are expected to increase 13.2% in 2019 according to data compiled by Standard and Poor’s.
- The US federal government is running large deficits causing the already large national debt to increase. This may crowd out private borrowing and reduce the government’s ability to increase spending in order to fight a future recession. However, the interest rate paid on 10-year US Treasury Bonds has remained low showing a strong investor appetite for government bonds.
- Political uncertainty and bipartisanship may lead to policy mistakes that could have a negative impact on the markets and the economy. There is no doubt these are polarizing times in which people across the political spectrum seem concerned about policy decisions. However, historically the stock market has done well during periods of political gridlock as it reduces the chances that major legislation will have negative implications on the business or market environment.
Naturally, each of these issues represents a risk that investors should monitor. However, it is equally important to avoid overreacting to potential risks that are not supported by real data. The stock market is considered to be a leading economic indicator because it often declines before the economy enters a recession. However, the stock market is also very prone to false signals in which the market declines in value but then quickly bounces back when the feared weakness in the economy fails to materialize. For this reason it is important to focus on hard data in addition to market price trends.