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Stock Market Outlook: What Could Spring Up in May?

Investors are divided where the market will go next, but a few pivotal events in May should begin to make things clearer.
Updated May 1, 2018
Investing, Investing Data, Investing Strategy, Investments
Stock Market Outlook May 2018

Just as one person’s trash may be another’s treasure, the U.S. stock market has something for both bears and bulls right now. The pessimists believe stock prices are doomed to fall precipitously from current levels — while optimists say they’re poised to rebound.

If only we knew which camp was correct.

The question of what’s ahead for the stock market is ever-present, and not least because 2018 has been a year of surprises for many investors. The S&P 500 has posted some of its biggest daily gains and losses in years, but also sank into its first 10% correction in about two years. And nearly three months later, the gauge remains in correction territory, the longest period for one of these market events in almost a decade.

While the return to a more volatile market is mostly heralded as positive by professional investors, navigating this type of market can be frustrating. (New to this? Learn how to invest money.)

From the Treasury market to geopolitics, here’s what professional investors will be watching in the month ahead.

Where do bond yields go from here?

Stock market investors have been fretting about the bond market for months, and in late April, the yield on 10-year U.S. Treasury bonds finally hit a 3% threshold for the first time since 2014. This level, while arguably somewhat arbitrary, was seen as a possible harbinger of stock market weakness.

» Read more: Why interest rates matter to the stock market

Even so, questions about where yields are headed remain top of mind. DataTrek Research recently conducted a survey of investors, and respondents “overwhelmingly” said they expect the 10-year yield to rise as high as 3.25% by year-end, says Nicholas Colas, the company’s co-founder.

Rates will continue to be a big part of the conversation for stock investors in May, Colas says, and that’s because of broader implications, including:

  1. How aggressive will Federal Reserve policymakers be in raising rates in the balance of the year — will they raise rates three times this year (the first rise happened in March) or four?
  2. Will the yield curve, which measures the spread between long- and short-term yields, invert (meaning short-term yields are higher than long-term yields)? Historically, an inverted yield curve has been a reliable indicator of a future recession.
  3. What impact will the above factors have on the stock market?

As for the question of what’s driving bond yields higher? It’s a “triple play of forces,” say Brian Jacobsen, chief portfolio strategist at Wells Fargo Asset Management.

The base case scenario is three hikes; that’s what most investors are expecting. The question is do they hint toward four or not?

Chris Zaccarelli, chief investment officer at Independent Advisor Alliance

Publicly traded companies are in the midst of reporting first-quarter earnings, which have been good, and that’s “brightened” the outlook for economic growth that will support higher rates, Jacobsen says. Meanwhile, rising oil prices have helped increase inflation expectations and central bankers have been “talking up, rather than talking down,” further hike rates, he adds.

» Plan ahead: How to protect your 401(k) from rising interest rates

Investors broadly expect the Federal Reserve will raise rates when it convenes for its June meeting, but they’ll be looking for any hints about what will follow over the balance of the year, says Chris Zaccarelli, chief investment officer at Independent Advisor Alliance.

“The base case scenario is three hikes; that’s what most investors are expecting,” he says. “The question is do they hint toward four or not?”

How to prepare: The market has been “noisy” this year, with more volatility created by short-term, headline-driven swings, Zaccarelli says. Long-term investors should instead focus on the fundamentals that support stock prices — corporate earnings and the economy — which remain positive, he says. “Last year, you should’ve been patient, and this year you should be patient; the difference is it’s just not as fun to look at your holdings on a day-to-day basis.”

Can investors afford to go away after May?

One of the most famous stock market sayings is “Sell in May and go away.” This adage, which purportedly dates back to old England, suggests investors should sell stocks in May and return after September so as to avoid the less active summertime months when volatility can be higher.

After a year that was “ridiculously low” for volatility — in 2017 the S&P 500 moved in excess of 1% either up or down only eight times — investors should expect the market will continue to feel very choppy, Colas says. So far this year, the S&P 500 has notched more than 30 moves in excess of 1%.

As for potential sources of volatility, look to geopolitics.

“Anybody hoping for a quiet summer this year, it’s just not going to happen,” Colas says. Historically, market choppiness in the first quarter, with an incidence of 1% moves similar to this year’s, has seen such volatility persist through the rest of the year — though the S&P 500 still delivers an average return of 6%, he says, citing his analysis.

As for potential sources of volatility, look to geopolitics. North Korea has been a source of concern for many investors, but in March, President Donald Trump agreed to meet with Kim Jong Un, North Korea’s leader — and that meeting could take place as soon as May.

“The market is either expecting a neutral or positive outcome from this; they’re not expecting anything negative,” Zaccarelli says. “Easing of tensions is now sort-of status quo.”

Closer to home, Jacobsen says he’ll be closely watching the upcoming Mexican elections in July. Left-wing presidential candidate Andrés Manuel López Obrador currently leads in the polls, and if elected, he could “undo some of the free market reforms that have been put in place over the last few years,” Jacobsen says. “It’s crunch time for NAFTA negotiators to get something done before the election.”

Lastly, the weeks-long period known as earnings season — when publicly traded companies report their quarterly results — will end in May. Even amid “excellent” earnings, stock prices haven’t gotten a boost, Zaccarelli says. While this may seem counterintuitive to some, the market is forward-looking, so this optimistic outlook was already factored into stock prices, he adds.

What are the best stocks to be invested in, given all the market dynamics right now? Even though several big-name technology companies have received a lot of negative press lately, these stocks still are the place to be, according to Colas.

“It’s going to feel scary, but these are still very good companies with very good fundamentals,” he says.

Stock market forecast

Many pundits promised that the market’s February correction was “healthy,” but that’s likely of little consolation if the value of your portfolio is still lower than it was at the start of the year. As frustrating as the market has been this year, if you’re invested for the long haul, you shouldn’t stress about the events of one day, one week or even one month.

As for the outlook for U.S. stocks, consumers have a different take than Wall Street right now. A majority of consumers expect stock prices will be lower 12 months from now, which marks the highest gauge of such skepticism since November 2016, according to recent sentiment reading from the Conference Board. Meanwhile, analysts’ target prices for all stocks in this index suggest the S&P 500 could climb to 3,069.77 this year, according to data compiled by FactSet. That’s an increase of more than 15% from Monday’s closing tally of 2,648.05.

Buying when stock prices are fluctuating can be intimidating — at the same time, trying to time swings in the market based on short-term disruptions is difficult to do successfully, even for professionals. Instead focus on the facts: Stocks have proven to be a fantastic long-term investment.

The market undoubtedly will go up and down in the course of your investing timeline. One way to minimize the risk of a big shock to your portfolio is to ensure you spread money across a variety of assets and develop a discipline of investing regularly.

Finally, long-term investors can be opportunistic and take advantage of market dips. Dollar-cost averaging, which involves regularly adding money to your investments to help smooth out your purchase price, ensures you won’t dump all your money in when stock prices are at a peak.

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