The start of a New Year is usually a time filled with hope and optimism, but those are rare commodities for equity traders and investors right now. What started as a wobble in October extended into a full-on collapse by the end of December. Early this morning, futures suggested another big drop in the major indices, but that is rapidly reversing, and there looks like being an early morning surge.
It seems then that we are going to start this year as we ended last, with extreme volatility and a whiff of panic in the air. However, both logic and history indicate that that state won’t be sustained for the whole year, so what should we expect?
There are two possible outcomes to the year. The bears could continue to run the show, even if that results in stagnation or steady declines rather than the kind of dramatic movements we have seen recently or, it could be a year of recovery when the bulls take over. As a wise man once said, predictions are hard, particularly those about the future, but it is worth examining both the bull and bear case for stocks in 2019.
Doing so may not tell us for sure what will happen, but it will give a framework within which we can understand what does.
The Bear Case:
More accurately, I should say the bear cases, in the plural, as there are a whole host of things that could keep stock prices depressed this year or even send then lower.
The primary determinant of price for stocks is corporate profitability, and after a number of companies lowered expectations for at least the first quarter of 2019, lower profits must be a possibility. The main reasons for the pessimism seem to be the effects of the ongoing trade war, particularly with China, and the possibility of a global slowdown as a result.
As I said a few weeks ago, the trade war issue is easily reversible, and a President under enormous political pressure may well choose to do just that. This Presidency, however, has not so far been predictable in any way, so investors should keep an eye on whether Trump takes a more conciliatory tone or continues to double down on the aggression.
The politics that make a resolution of the trade dispute a possibility are themselves a risk though. There are indications that the Mueller report is coming before long, and if the indictments so far are anything to go, by it will not be good news for the President. If that is the case, it could easily spark a constitutional crisis that will prompt another crisis of confidence in the stock market.
Add in the potential for negative effects if the Fed continues to hike rates, the uncertainty around Brexit, and the hard evidence of a slowdown in China, and it seems inevitable that something will happen early in the year that will cause another big drop.
That is the basis of the bear case, that there are so many threats to the economy out there that something has to go wrong.
The Bull Case:
Essentially, the argument for stocks moving higher next year can be distilled into two words: enough already!
As I have pointed out on many occasions, the move down started because of fear, not anything that actually happened, and that same fear has continued to drive the market ever lower. Even if we accept that there are some signs of weakness beginning to show in the data, both here in the U.S. and overseas, they are not nearly enough to justify a drop of around twenty percent in all the major indices.
What we are seeing is, after all, not a recessionary environment, but rather just slower growth than was previously expected. That is not good, but it is hardly a disaster that justifies a major market move. Unemployment is at all-time lows, growth is good, if not spectacular, and while some corporations are issuing conservative guidance, profits are still at record levels.
The bull case, therefore, is that whatever happens politically, with the Fed, or with the global economy, the U.S. economy will be strong enough to withstand it without any major disruption. Given the atmosphere of doom and gloom right now that may sound overly optimistic, but we should remember that all of these threats have been around for some time, yet U.S. GDP is still growing at a decent clip.
When you lay out both sides of the argument, one thing becomes clear about 2019: predictions for the next twelve months are even harder, and maybe even more pointless, than usual. Still, predicting is what I do, so I will have a stab at it.
Right now, there are so many things that could go wrong that it is hard to see stocks finishing the year higher. On the other hand, the default direction of stocks is upward, and a lot of the potential bad news is already priced in. On balance, the second argument, being based on what is rather than what might be, has more appeal, but the one thing I can predict with confidence is that it will be a bumpy ride for investors in 2019.