Recent Sell-Off in Stocks May Offer a Rally in 2019

Steep drop in stocks without a recession signals opportunities for investors, say experts
December 31, 2018 Updated: December 31, 2018

WASHINGTON—December will go down as an unusually volatile period for Wall Street, but despite the wild swings heading into the end of 2018, some investors believe now is a good time to invest in U.S. stocks for the long term.

The Dow Jones Industrial Average ended the year down 5.6 percent. The index suffered a deep plunge since it broke its all-time high in October and had its worst December since 1931.

S&P 500 followed a similar trajectory, closing the year down 6.2 percent and the Nasdaq Composite was off 4 percent. This puts 2018 as the market’s worst year since the Great Recession of 2008.

Markets have recently become increasingly concerned about a possible recession in 2019. Some investors, however, believe these worries are overstated and think solid fundamentals and current valuations present a good opportunity for investment in U.S. stocks.

“We actually had been viewing the most recent market action as a buying opportunity,” said Brian Jacobsen, a multi-asset strategist at Wells Fargo Asset Management.

“If history is any guide we’re probably going to reclaim the previous highs sometime in 2019 and my best guess is that it will be sooner rather than later.”

Before the latest rebound, stocks plunged for four straight trading days and staged the worst-ever Christmas Eve performance. The recent sell-off pushed the S&P 500 near bear market territory, which means a 20 percent drop from its recent peak.

Jacobsen said there are historical experiences such as in 1998 and 2011 when stocks recovered after falling almost 20 percent. It took three quarters for the S&P 500 to recover in 2011. And the recovery was much faster in 1998. Amid Russian debt default of 1998, the index regained its previous highs in 46 days.

In both cases, the U.S. economic fundamentals reclaimed attention and helped propel the market higher, Jacobsen said.

No Signs of Recession

Investors are currently skittish due to talks about the inverted U.S. Treasury yield curve and slowing housing market, which are widely considered to signal an impending recession.

Goldman Sachs, however, says the recent market plunge does not indicate an economic downturn.

In its latest report, the investment bank revised down its U.S. growth forecast for the first half of 2019 from 2.4 percent to 2 percent in light of the Fed’s tightening monetary policy and weaker U.S. data. “However, we are still not particularly worried about a recession,” Goldman’s chief economist, Jan Hatzius, wrote in the report.

According to Hatzius, the two key risk factors—inflationary overheating and asset market bubbles—remain absent. Valuations do not look excessive given a substantial rise in corporate earnings and the recent drop in asset prices, he noted.

“More importantly, the private sector remains in very good financial shape and looks much less vulnerable to a decline in asset prices or a tightening in lending standards than in the last several cycles,” he said.

Despite recent wild swings in Wall Street, the U.S. stock market outperformed major markets around the world.

The German DAX had its worst year in a decade, falling more than 18 percent since the start of the year. The FTSE 100 ended the year down 12.5 percent. China closed the year as the worst performing major stock market in the world. Major indexes in Shanghai and Shenzhen both lost more than 24 percent in 2018.

Chinese stocks crashed as the trade war with the United States and the economic slowdown intensified investor worries. Stocks lost nearly $2.3 trillion in market value in 2018. Besides the trade war, which grabbed much of the attention in 2018, Beijing’s deleveraging efforts in the financial system played a big role in the stock market plunge.

Markets at Mercy of Fed

The U.S. stocks may continue to outperform in 2019. However, some experts predict that stock market performance is at the mercy of the Fed at least for the short term.

Stocks may rally in the first three months of the year, according to J.P. Morgan, so long as the Fed holds the interest rates steady in its March meeting.

“Signs of capitulation by institutional investors are creating a window of opportunity for equity markets into Q1 assuming the Fed reacts to market stress,” J.P. Morgan analyst Nikolaos Panigirtzoglou wrote in a note to investors on Dec. 28.

In its December meeting, the Fed raised its benchmark interest rate and lowered its forecast of rate hikes next year to two from three. Despite its dovish tone for next year, Fed Chairman Jerome Powell failed to assure markets that the central bank was easing off its tighter policy approach as much as markets had expected. Stocks initially rose after the December meeting but fell sharply during Powell’s post-meeting press conference.

According to Panigirtzoglou, whether the Fed gets even more dovish next year will be the key factor in determining the market comeback at the beginning of 2019.

“If such dovish shift does not materialize and the yield curve inversion fails to improve, any equity rally in Q1 would most likely be short-lived,” Panigirtzoglou said.

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