The 3 biggest risks to stocks in 2019

After such a ...

Posted: Jan 2, 2019 12:27 PM
Updated: Jan 2, 2019 12:27 PM

After such a volatile 2018, predicting what the US stock market will do in 2019 is like guessing where a single piece of paper will land in a windstorm.

Few saw last year's market mayhem coming after an unusually sanguine and calm 2017.

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Investors have some reasons for optimism in 2019: The economy remains relatively strong. Companies' fundamentals appear robust too, and stocks are undervalued compared to their expected earnings.

Yet political turmoil, rising protectionism, a hawkish Fed and slowing earnings and economic growth have sent shivers down investors' spines lately.

Those fears caused markets to jolt up and (mostly) down in dramatic fashion in 2018. So what are the risks for investors in 2019?

1: Slower earnings growth

The stock market responds to many data points, but corporate earnings are the most important of them all. If companies grow, their stocks typically rise.

Wall Street analysts expect earnings in 2019 will grow far less than than they did in 2018.

Corporate profits rose 23% in 2018 because companies were shot with a caffeine injection from the tax cuts at the beginning of the year. That buzz has already started to wear off, and 2019's growth won't look nearly as hot by comparison.

The dollar has also been rising throughout 2018. The US Dollar Index added about 5%, pinching corporate profits for America's multinational companies. A strong dollar makes US products more expensive abroad and can dampen international sales.

Lindsey Bell, CFRA Research Investment Strategist, told CNN Business she expects earnings to grow 7% in 2019. That's about on par with Wall Street's profit growth forecast of less than 10%.

That's strong, but not exactly something investors are thrilled about.

Still, the S&P 500 is trading at just 14.5 times 2019's expected earnings, well below its historical average of 16 times earnings. That's one reason why stock analysts believe markets are due for a comeback. Also, stocks were so universally battered that 2018's best sector (health care) rose just 5%, while the worst sector (energy) fell 18.5%. That tight range between the best and worst sectors is well below average — typically a positive omen for stocks the following year.

"Should history repeat, and there's no guarantee it will, this year's lump of coal could metamorphize into an unanticipated gem," said Sam Stovall, chief investment strategist at CFRA Research.

But even if they do bounce back, can stocks sustain a rally?

Sure, says Tony Dwyer, analyst at Canaccord Genuity. Perhaps for a time. But even if stocks bounce back, he doubts the enthusiasm will last.

2: A global economic slowdown

Most economists aren't predicting a recession around the corner.

That alone has some market analysts questioning why stocks have fallen so dramatically in recent months.

"Once the market realizes a recession isn't imminent, it will find a bottom and slowly climb back to all-time highs again," said Chris Zaccarelli, chief investment officer at Independent Advisor Alliance.

But America's economic expansion, the second-longest in history, is under threat.

Boosted by the tax cuts and the lowest unemployment rate in a generation, the US economy boomed in the middle of 2018, growing at an annual rate of 4.2% in the second quarter and 3.4% in the third quarter. But the Federal Reserve believes the pace of economic expansion will slow in 2019 to 2.3%.

After decades of sharp expansion, the Chinese economy is slowing down, too. Growth in 2018 is set to be the weakest since 1990. And 2019 looks even worse. Brexit could knock the United Kingdom off its feet in 2019.

Fear of a global economic slowdown has dragged stocks from their all-time highs set in late September. Investors worry about the Federal Reserve's plans for 2019. If it raises rates too quickly, the Fed could artificially slow the economy or even bring about a recession. Inflation is not currently a problem, so the central bank has the ability to slow its rate-raising pace if it wants.

"If the Fed continues to ignore the weakening inflation data and maintains their current projected path, it could cause an even bigger disaster," said Dwyer.

By contrast, if the Fed signals it will stop hiking rates, Dwyer believes stocks could reach new highs in 2019.

3: Political instability

Dysfunction in Washington and the United Kingdom have thrown investors for a loop.

No one knows what to make of Brexit, other than it's bad no matter what form it takes — and potentially disastrous if March 29 rolls around without a deal.

The US government shutdown probably won't mean much for the economy in the near term, but it has concerned investors that the impasse may portend bad news for a looming debt ceiling showdown.

American lawmakers must pass a law this year so the Treasury Department can continue to borrow without any restrictions. If they fail, the government could default on its debt. When that nearly happened in 2011, credit-rating agency Standard and Poor's downgraded America one notch below a perfect AAA. Another downgrade could make the United States' already massive debt load much costlier to pay back.

Trade tensions still loom over the economy and markets, too. The Trump administration is threatening to raise tariffs on billions of dollars worth of Chinese goods if China fails to meet US demands on a variety of economic and political issues. American companies pay those tariffs, and they pass costs onto consumers, who account for two-thirds of America's GDP.

And Trump's continued threats to undermine the Fed chair that he appointed show no signs of abating. Investors may not love Federal Reserve Chairman Jerome Powell's hawkish policy, but they crave consistency, and threatening to unseat a Fed chair in the middle of his term could throw the markets into chaos.

"As the market continues to worry about a recession, the implications of a trade war with China and unpredictable and adverse political decision-making from the White House, we are going to continue to see volatility," said Zaccarelli.

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