Monday, December 3, 2018

Markets Are Revealing the Sum of All Risks

Markets Are Revealing the Sum of All Risks

There’s not a main reason for the sell-off, but a widening sense of unease that several types of problems are rising at once.
Markets are reflecting gathering risks. A view of the New York Stock Exchange from Federal Hall National Memorial.CreditMary Altaffer/Associated Press

Markets are reflecting gathering risks. A view of the New York Stock Exchange from Federal Hall National Memorial.CreditMary Altaffer/Associated Press
The most telling thing about the pummeling that the stock market has taken recently, and especially this week, is that there’s no simple single cause to point to.
That reflects the fundamental economic risk for 2019 and beyond. There isn’t a lone caution on the horizon that can be identified and monitored and that policymakers can respond to.
Rather, markets reflect a widening sense of unease that several different types of risks are rising at once — and that although any one of them might be manageable, together they could lead the economy into serious trouble in 2019 or 2020.
This emerging conventional wisdom is far ahead of the facts on the ground: Most economic data lately has pointed to continued healthy growth.

And while stocks are down 9.5 percent since early October, the yield on longer-term Treasury bonds is at about the same level. The bond market tends to be more closely tethered to the direction of the overall economy than stocks, so that suggests investors in recent weeks have not radically reshaped their view on future growth.
But when you tick through the list of fears causing the sell-off, it’s easy to see why stock investors in particular are getting jittery, driving steep market drops Monday and Tuesday.
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The giant tech companies that have propelled the market for years are facing risks of slowing growth (especially Apple) and new regulation (especially Facebook). Oil prices are plummeting, sending the share prices of energy companies downward. Investors are starting to worry that companies with heavy debt loads could struggle to handle them, with General Electric as Exhibit A. The trade war, long at a steady simmer, could boil over at any time.
Oh, and economic growth seems to be slowing worldwide. The United States housing market is in a slump. And forecasters expect the stimulative effects of tax cuts to fade in the coming quarters. That makes a slowdown in the rate of growth appear more likely than not, especially if the Federal Reserve persists with interest rate increases amid a slower-growing economy.
But before running for the hills in panic, there are a few things worth considering. First, bad things happen all the time in the economy, and in markets. Usually, the damage is localized to the industries directly affected.

Take the tightening of corporate credit that is underway, with interest rates for riskier companies soaring. It has echoes of the not-too-distant past. In the mid-2000s, American automakers were overleveraged and facing a difficult environment. General Motors and Ford bonds were cut to junk status in 2005.
Bondholders and credit ratings agencies lost confidence in those industrial icons’ corporate debt, causing plenty of pain for the automakers’ employees and stock prices. But the overall economy kept humming along. (It was a recession rooted in other sectors, three years later, that dragged American automakers toward bankruptcy.)
Similarly, it’s easy to look at the slowdown in home sales and building activity, for example, and fear that it could lead to a repeat of the 2008 recession.
But in that episode, housing starts peaked in January 2006. For nearly two years, the economy largely held up; as housing contracted, other sectors grew. It was only after the housing downturn triggered a financial crisis that a recession began in December 2007.
In terms of a slowing global economy, in 1998 an emerging markets crisis seemed to endanger a booming American economy enough that the Federal Reserve cut interest rates late that year to try to guard against damage. As it turned out, 1999 was a boom year.
What these episodes all show is that adjustments — whether in the credit markets, the housing market or emerging markets — tend to cause huge economic disruption only if there are compounding factors, or inadequate policy responses.
Already in the last couple of weeks, top Federal Reserve officials have softened their tone about how high they will eventually push interest rates.

The implicit message: If all of these negative forces really do start to harm growth, the Fed will slow the pace of rate increases, rather than stick to some preordained path.
The great fear for the economy in the next couple of years shouldn’t be the risks we know about. It is that those risks will materialize and interact in unpredictable ways, and together cause damage that none of them alone could. And if that happens, the last few weeks will look like a crucial moment when it began.

Neil Irwin is a senior economics correspondent for The Upshot. He previously wrote for The Washington Post and is the author of “The Alchemists: Three Central Bankers and a World on Fire.” @Neil_Irwin  Facebook
A version of this article appears in print on , on Page B1 of the New York edition with the headline: The Swoon And the Sum Of All RisksOrder Reprints | Today’s Paper | Subscribe

Stock Market’s Dangers Are Easier to See

The Stock Market’s Dangers Are Easier to See Now

CreditYarek Waszul
CreditCreditYarek Waszul
Project ahead a year or two: It is much easier to make a case for a troubled stock market than for a booming one.
Start with the performance of the market itself. Although stocks surged on Wednesday, a rocky autumn wiped out most of the year’s gains, and investors are having difficulty mustering arguments for a market that has been unable to sustain upward momentum.
Paul Hickey, a founder of Bespoke Investment Group, an independent market research firm, regularly tallies what he calls “the pros and cons” of the stock market. I asked him for an informal update: He came up with 14 pros versus 22 cons.
That abundance of negativity isn’t intended as a quantitative assessment of the market’s prospects, but it does give a rough sense of his view and, I think, of the perspective of many skittish investors.
“We were bullish for a long time, but right now I’d say I’m in a wait-and-see mode,” Mr. Hickey said. “I think it’s a time to be cautious.”
I also asked James W. Paulsen, chief investment strategist of the Leuthold Group, an investment research firm in Minneapolis, for his sense of the market. An economist, Mr. Paulsen is worried about stocks because he is worried about the economy, he said. While the United States is not in a recession now, he said, “we have moved into the ballpark of a recession.”
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Mr. Paulsen said neither he nor anyone else could reliably forecast a recession. “That kind of prediction is just too hard to do,” he said. But, he added, it is possible to judge when the risks of recession have risen.
“It gets somewhat easy, with a little experience, to recognize when you’re in the ballpark of a recession,” Mr. Paulsen said. “That is where we are now, and that alone is quite a bit of information.”
Given his current outlook, which is that the probability of a recession within two years is reasonably high though not certain, “this is a good moment to take a little risk out of your portfolio, just in case things turn down,” he said.
The stock market, Mr. Paulsen said, often moves in advance of a recession — and a declining market can help cause a recession — making investment timing extremely difficult now. In this dangerous environment, he said, “right now, I’d be a little careful.”
Mr. Hickey, too, advises caution, because when he enumerates the pros and cons for the market, the positive side is scanty. It includes factors like these:
■ Despite some difficulties, the gross domestic product in the United States rose at a 3.5 percent annual rate in the third quarter.
■ The Conference Board’s Leading Economic Indicators index has been rising, which suggests that a recession is probably not imminent.
■ The yield curve — the difference between long- and short-term interest rates — remains in a bullish zone, although that positive margin has been narrowing and bears close watching.
■ The end of the Federal Reserve’s interest rate tightening cycle may be in sight. Jerome H. Powell, the Fed chairman, said on Wednesday that interest rates were already close to a “neutral” level, which might imply that rates won’t rise much higher.
■ Finally, there is already so much bad news about the stock market that it amounts to good news. According to contrarian logic, Mr. Hickey said, the negatives are baked into stock prices, so the market has room to rise.
That last item may be a stretch. It is an indication, he said, that he is having difficulty being upbeat.
The stock market negatives on Mr. Hickey’s list, by contrast, are straightforward. A sampling includes these items:
■ The trend of stock prices has been quite negative. While a string of strong days could turn that around, momentum is bearish.
■ Despite Mr. Powell’s latest comments, the Fed is still tightening monetary policy, which could easily derail the stock market and the economy.
■ The fiscal stimulus provided by the tax cut is, increasingly, behind us. Combined with tighter monetary policy, the loss of fiscal stimulus could hurt the American economy.
■ Tariffs have been rising, and business sentiment has been depressed by the prospect of widening trade wars.
■ Global economic growth has been slowing, and many stock markets around the world are already in bear market territory.
■ The domestic housing market has weakened, homebuilder stocks have plunged, commodity prices have fallen, and auto sales are relatively weak.
■ The tech sector, which propelled the market higher earlier in the year, has now lost hundreds of billions of dollars in value. Because of the importance of stocks like Amazon, Facebook, Netflix, Alphabet (Google) and Apple, the psychological “impact of their weakness can’t be overstated,” Mr. Hickey said.
■ Corporate debt levels are high, creating new vulnerabilities.
■ The rate of earnings growth is likely to decline. That could disappoint Wall Street analysts and shake up the market.
And that’s just a start. The negatives go on and on.
In the 10th year of both an economic expansion and a great bull market, of course, it’s not surprising that warning signals have begun to flash. At this stage, as I wrote recently, it seems wise to be prepared for downturns.
Yet even despite these portents, a gloomy financial outlook may not be entirely appropriate. For example, neither Mr. Hickey nor Mr. Paulsen is confident that the bull market is over or that a recession is likely to arrive soon.
“There could be another strong bull run,” Mr. Hickey said. “But I don’t think we’ll have a good sense of that until at least the end of the year.”
I asked Mr. Paulsen to make the strongest case he reasonably could for upbeat economic and market outcomes for the next two years. In response, he said it was possible that the Fed would soften its monetary policy enough to extend the economic recovery and bolster the stock market. If the economy keeps growing and corporate earnings keep rising, Mr. Paulsen said, stocks will rise, too.
The odd conditions of 2018 have already made stock valuations more attractive. Because prices have been flat while earnings have risen, the price-to-earnings ratio of the S&P 500 has declined to about 18, from about 23.5 in January, he pointed out.
If that trend continues, Mr. Paulsen said, stocks might become rather enticing. “If we don’t go into a recession and if interest rates don’t rise too much, at some point stocks could look good enough to set off another bull run,” he said.
But he added that he wouldn’t bet on it with money needed to pay the bills in the next couple of years.
After a nearly 10-year bull run, the downside of the market is becoming increasingly obvious.
Follow Jeff Sommer on Twitter: @jeffsommer.
A version of this article appears in print on , on Page BU4 of the New York edition with the headline: The Stock Market’s Dangers Are Easier to See NowOrder Reprints | Today’s Paper | Subscribe