Investors in the U.S. stock market certainly are relieved that 2018 is over.
No wonder. It was a bruising year, the worst since 2008 during the financial crisis, as the S&P 500 fell 6.2% and a bear market seemed all but inevitable. In late December, with the S&P 500 down more than 19% from a September high, investors had to brush up on their definition of a bear market, a decline of at least 20% on a closing basis. The Nasdaq Composite Index and Russell 2000 Index were among stock indexes that tumbled into bear markets.
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The question on everyone’s mind on Wall Street is: Will the new year bring relief or more pain? Investors are bracing for more subdued economic growth and corporate profit growth ahead, though they’re generally not betting on a recession for at least another year. But with the prospect of more uncertainty from the Federal Reserve and ongoing trade talks with China, some investors find it difficult to be bullish right now. Here’s what professional investors will be watching this month.
The market vs. the Fed
As widely anticipated, the Federal Reserve’s Open Market Committee raised the target for interest rates at its December meeting, the fourth time in 2018. While central bankers signaled they would raise rates only twice in 2019, that did little to appease investors.
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“The market interpreted it as not dovish enough,” says Ryan Detrick, senior market strategist at LPL Financial, suggesting investors had hoped the Fed might signal an even more restrained approach to future rate increases. The market’s immediate reaction — the S&P 500 slumped 2.5% in the days following the Fed meeting — shows there’s still a disconnect between what investors see (slowing economic growth) versus what policymakers see (economic growth still is pretty good), he says.
Clearly Fed policy is front and center to a lot of what is driving financial markets these days.
“The question is, who’s going to break first,” Detrick says. Most Americans have seen sluggish wage growth for years, and that’s one reason the Fed is intent on continuing to raise interest rates, “but that might be at the detriment of the stock market,” he adds.
The Federal Reserve committee is slated to meet again Jan. 29-30, though investors don’t expect another hike at that time. Rather, they’ll scrutinize any commentary from Fed officials in the interim to try to predict the central bank’s next steps.
“Clearly Fed policy is front and center to a lot of what is driving financial markets these days,” says Mark Heppenstall, chief investment officer of Penn Mutual Asset Management in Horsham, Pennsylvania. Heppenstall anticipates Fed Chairman Jerome Powell and other central bankers will try to assure markets with the Fed’s plans for a less-aggressive path ahead. “I do think it’s likely December’s meeting will be followed up by additional validation of the dovish projection.”
Meanwhile, one lingering issue has been overshadowed by the Fed lately: trade talks with China. The U.S. and China are set to resume meetings to come to an agreement in January, and some resolution “could be one major positive” for the stock market, Detrick says.
What to do now
It may be a good time to take a look at the fixed income portion of your portfolio, that is, bonds. There are opportunities in this market that are “as attractive as it has been since early 2016,” Heppenstall says. He recommends investors consider mutual funds that track the corporate credit bond market or offer exposure to the consumer credit market.
» Read more: How to build your allocation in bonds
Embracing a late-stage market cycle
Like many things in life, the market moves in cycles. There are years of robust gains, like 2009’s 23%-plus return for the S&P 500, and years of choppiness (ahem, looking at you, 2018). But with the bull market’s 10-year anniversary in March, many investors recognize that the best days may be over, even if the rally itself is not.
Companies will begin reporting results for the fourth quarter in mid-January, and expectations already have been scaled back. Analysts expect companies in the S&P 500 will report earnings that are 12.4% higher than the same period a year ago, down from a prior forecast of 16.6% in late September.
Investors had grown accustomed to double-digit earnings growth, but that’s not sustainable, especially if wages start to grow (which will cut into profit) and as the benefit of corporate tax cuts wane, Heppenstall says. “The bar has been set too high for earnings to grow at the same growth rate,” he adds. Analysts are forecasting single-digit growth into late 2019.
Another characteristic of a bull market in its latter stages? Volatility. Moves in excess of 1% in either direction were commonplace in 2018 — happening more than 25% of trading days — and investors should brace for more ahead, Detrick says. Instead of getting spooked, he advises long-term investors to consider an opportunistic approach when stock prices have fallen.
“There’s a famous quote on Wall Street: ‘The stock market is the only place where things go on sale and people go running out of the building screaming,’” Detrick says. “It feels pretty dour right now, but if you stay in the store, you could get some stocks at pretty cheap prices.”
What to do now
In terms of which stocks look attractive, the latter stages of a market historically benefit value stocks, Detrick says. Those stocks have low prices and promising long-term prospects, unlike the market’s highflyers, known as growth stocks. (New to this? Read up on these two investing styles.) For long-term investors, now is a good time to “embrace the volatility,” he adds.
» Read more: How to research stocks
Stock market forecast
By December, a majority of the companies in the S&P 500 had fallen into a bear market, even though the index itself barely fought one off. History shows it’s rare for the stock market to enter a bear market during non-recessionary periods, Detrick says. In 1998 and 2011, the S&P 500 also came close, down more than 19% in both cases, when there wasn’t a recession on the horizon, he notes. (A recession is defined as two consecutive quarters of declines in GDP.)
Still, it’s no surprise investors both on and off Wall Street have become spooked:
- Among advisors, 89% say they’ve talked with their clients about preparing for a bear market, according to a recent survey from Hartford Funds.
- More than half of individual investors said in December they expect stock prices will be lower in the next six months. That was the most bearish reading since 2013, according to a weekly sentiment survey conducted by the American Association of Individual Investors.
Even if investors are feeling less optimistic, history is reliable in one sense: The stock market has bounced back from worse. The following calculator shows how long it took for the S&P 500 to recoup losses from prior market selloffs.
While there’s no “right” time to buy into the market, the recent volatility may feel like the wrong time to do so. But it’s best to fight those fears and keep investing, especially given the stock market’s proven history as a long-term investment, with historical average returns of about 10%.
Keep these simple mantras in mind when investing for the long-term:
- When investing, volatility is a given. If you expect it, you don’t need to stress about daily gyrations.
- Don’t try to time the market. Try to sell when you think the market’s peaked and you’ll likely be wrong.
- Add money to the market at regular intervals. This strategy, known as dollar-cost averaging, smooths out the price you pay for stocks over time.
- Diversify your portfolio to reduce overall risk. That means a good mix of different types of stocks and bonds, as well as assets from other geographic regions.