The 3 Things that Threaten the Stock Rally

Look out below if the Fed doesn’t ease much, earnings dip, or the trade war heats up.

The S&P 500 and the Nasdaq Composite hit record highs Wednesday, despite a federal investigation of Big Tech, a sector that has been the primary engine of this rally. Boy, except for the occasional blip, it seems as if nothing can stop stocks’ advance.

At some point, of course, a big bad bear market will come along, as it always does. For a preview, look at what happened in last year’s final quarter, when the S&P 500 came within a whisker of sliding 20%, which is what constitutes a bear market. Then, fears over the US-China trade war and a slowing global economy were the catalysts.

What will be the death knell for this bull market, which has been running since March 2009, the longest in history? One or as many as three factors could slam investor confidence:

The Fed Disappoints. Next Wednesday, the Fed’s policymaking body is expected to lower the federal funds rate by a quarter percentage point. That’s the verdict of the CME’s Fed futures, which forecast a 75% probability that it does so.

But what if, for whatever reason, the Fed doesn’t go along with this? Or what if the Federal Open Market Committee, as the panel is known formally, only delivers that single interest rate drop? James Bullard, the St. Louis Fed president, is an advocate for such a one and done move.

The stock market is primed for more reductions than that. By year’s end, the CME projects (by 37%) a total of three quarter-point decreases, namely July 31 and two additional. And 33% look for only one extra cut after next week, for a total of two in 2019. 

Earnings Slide. Stocks discount future earnings, which is another way of saying that rising profits are the fuel for a bull market. Earnings growth, though, is weakening. According to CFRA’s analyst consensus of second-quarter results, operating earnings per share will drop 1.3% year over year. And the third quarter EPS should fall an almost identical amount, the research shops says.

The Trade War Worsens. Talks are about to resume between the Americans and the Chinese. Still, wide gaps remain. Just when the world seemed assured that a US-China agreement was imminent, President Donald Trump shocked the world in early May when he threatened to boost tariffs on Chinese imports because the talks were moving too slowly and Beijing wanted to renegotiate what he thought was settled. 

So the entire trade situation is mercurial. It could swing back to bad, then to very, very bad. If so, the market will not take kindly to the situation. Ditto if rates don’t ease materially and earnings fall apart.

Yes, many things about the underlying economy—you know, the entity that drives the market ultimately—are in good shape. Retail sales and industrial production beat expectations in June, with both climbing 0.4%. Core sales came in still better, up 0.7%. Overall manufacturing output was flat, yet it wasn’t down. And unemployment is at a low, low 3.7%.

Like the weather, however, things always can change for the worse, and suddenly.

Related Stories:

Trade War Could Shove US into a Recession, Morgan Stanley Says

If Earnings Have Peaked, Will a Stock Wipeout Follow?

Is an Earnings Recession Really Coming?

Fed Chair Hints He May Ease Off on Rate Boosts

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