Investor jitters have returned, spurred by real issues. With the Dow Jones Industrial Average languishing well below its January ~26,600 high, there is a growing risk of another drop that could easily slip into a shakeout.
Disclosure: Author holds only cash reserves
There are many negative (or less positive) issues that have popped up. Taken together, they could extract the remaining 2017 stock market optimism.
Recent less strong economic readings have revealed possible chinks in the economic growth armor. Various areas have had growth rate slips (e.g., housing) that produced “less, but…” commentary. The “buts” are used to assign the weaker reading to the aberration camp, but… that is how every economic slowdown and recession starts. While the hiccups are not serious enough now to be alarming, they do boost uncertainty.
A popular worry is the rising interest rate environment. A new experience for many, it introduces both real consequences and investment uncertainties.
Growing inflation, currently downplayed by the Fed and ignored by consumers, is beginning to raise businesses’ costs, and that means it will soon begin affecting prices. Moreover, experienced Wall Streeters remember the lack of Fed control over inflation that can occur when large national deficits/debts and sluggish/negative economic conditions meet.
Uncertainty about President Trump’s economic actions, such as tariffs and trade agreements, increase risk. Investors know that it was the sudden tariff announcements that put the market down in the first place.
The technical look of the stock market and its proximity to alarm-bell barriers. The key here is that the barriers are obvious to anyone looking at a graph. In addition, there has been widespread discussion about 10% being an acceptable correction level, so we should not worry. The problem is the market has overstayed (see “This Stock Market Is Providing Too Many ‘Closeout Sale’ Days – So, Raise Some Cash” for my explanation). Therefore, a breakthrough on the downside would likely not be cushioned by bargain buying.
Then there is the fretting about no market movement as “great” earnings reports roll in. The apparent mismatch can raise the specter of something amiss in the stock market. (See my article, “Worried About Flat Stock Market? Don’t Be,” for an counterargument.)
The consequences of a breakdown
Nothing unnerves an investor more than already being a bit concerned and having stocks drop sharply and noisily. It kills any lingering “buy on dips” confidence. Worse, it creates the susceptibility to selling out when articles appear explaining what is wrong and how it could get worse.
Therefore, if a breakdown occurs, there is a good chance that we will see a shakeout. There is plenty to worry about, and the market has gone for a long time without one.
On the other hand… The market could rise
The best argument for a rise is that fundamental growth is expected to reach new highs. The table below shows the latest calendar year earnings forecasts for the DJIA 30 companies (these earnings estimates are updated each week in the Barron’s “Market Laboratory”). Look especially at the final two columns showing projected earnings growth from 2017 to 2018 and 2018 to 2019. That is heady stuff. If the growth occurs, it will produce higher dividends and stock prices.
Could such a rise happen from these levels?
Yes, so long as an economic slump or recession does not occur. With current valuations reasonable, earnings growth forecasts could pull stock prices higher.
The bottom line
There are good reasons to expect a market selloff and possible shakeout. There are also good fundamentals to support a stock market rise. How to choose? It depends on an investor’s strategy and attitudes. There are three basic approaches:
- Long-term, fully-invested strategy with the capacity to ride through losing patches.
- Short-term, opportunistic strategy with the willingness to miss gains when in cash
- A combination, balanced or hedged approach that holds stocks in combination with other non-stock investments, including cash
(Disclosure: As is obvious by my holding only cash reserves currently, I fall into the #2 category.)