Everything was going right for the stock market until Oct. 3. Then everything went wrong.
Up to that point, the Dow Jones Industrial Average had been up about 8 percent for the year — a solid gain if not quite as gaudy as the year before.
More importantly, the fundamental backdrop was solid: The economy was growing at a better than 3 percent clip, corporate profits were around their highest levels in eight years, and the Federal Reserve seemed in control of monetary policy and interest rates.
The market traded flat that day, with little indication that there was anything that should disrupt the powerful bull run into the end of the year.
Then, it happened.
In a seemingly off-the-cuff remark in a PBS interview after the market had closed, Fed Chairman Jerome Powell said interest rates were “a long way ” from what he considered neither stimulative nor restrictive — the central bank’s holy grail of “neutral” where it could stay put over at least the medium term.
The comment garnered headlines but didn’t seem to generate an inordinate amount of attention.
The Dow dropped about 157 points the next day — a notable decline but not particularly scary for a blue-chip average that was knocking on the door of 27,000.
But then the next day it fell some more. And then some more. And then still more.
Ultimately, the index very briefly edged into bear market territory — a 20 percent drop. More importantly, the market’s worst fear was exposed, namely that a Fed that had been so generous in underpinning the bull market with scads of liquidity and low interest rates was now ready to change direction.
“We believe [the] Fed triggered [the] market panic of 2018,” Tom Lee, managing partner at Fundstrat Global Advisors, wrote.
As the days and weeks progressed, Wall Street suddenly had a new reality to face: A market that seemed bulletproof was now susceptible to a whole range of worries. Gains that had been taken for granted over the course of the last nine years were in jeopardy. A wobbly economy, an uncertain future with interest rates and a president who wouldn’t stop talking about the stock market posed grave dangers.
Worries become worrying
Lee termed the sell-off a “midlife crisis” for the market and not a recession. The market has a lot to overcome, though, to make him right.
While the Powell statement in itself was enough to set off a minor tidal wave in selling, it released a cascade of other concerns that investors had heretofore ignored and couldn’t be overcome even after the Fed chief tried to walk back the “long way” from neutral gaffe. Suddenly, the U.S.-China trade battle, of which Wall Street had largely taken the optimistic view i.e., that it would be settled with little global disruption, seemed an existential danger. Ditto for the global slowdown, a messy Brexit and the general chaos that had pervaded Washington since President Donald Trump’s election.
For his part, Trump didn’t help.
As Wall Street wobbled, the president turned up the heat on Powell and his colleagues. Intensifying criticism that had begun earlier in the year, Trump wondered aloud whether he had made the right choice in replacing former Fed Chair Janet Yellen with Powell and said over and over again that the central bank’s rate hikes were the biggest threat to the U.S. economy.
He went so far as to take on the Fed on Christmas Eve during a violent sell-off:
Trump’s strategy tying the stock market’s performance to the economy under his watch had always been a risky one, and with a potential bear market looming it became even riskier.
And it seemed the more he talked about the market, the worse things got, and investors continued to worry where the bottom would come.
Looking ahead, looking up
Still, there’s reason for optimism.
The economy remains strong, despite a Wall Street consensus that the pace of growth will slow. Unemployment is holding around a 50-year low and job growth continues apace, despite persistent conventional wisdom that there’s not much more room to expand and a worsening in labor conditions also could be in the cards.
Corporate profits, after growing just north of 20 percent for 2018, probably will slow as well, though an earnings recession seems nearly as unlikely as a conventional economic one. FactSet estimates earnings will grow 8 percent for all of 2019, a substantial decline but still a move forward. Consumer and business sentiment has edged lower but is still well above historical norms.
Moreover, there’s not a single strategist of the major Wall Street firms who thinks the market will finish 2019 lower than it started.
And even the Fed issues could fade from view. Current futures pricing anticipates zero rate hikes, and the central bank historically has been loathe to surprise the market, even though Fed officials currently project two increases before 2019 closes.
“With the last Fed decision of the year behind us and the market having gone through a dramatic pullback since, we believe that barring an appearance of a ‘black swan’ event, or the shock of a bolt from the blue, the worst of the declines experienced by stocks in 2018 are behind us,” John Stoltzfus, chief market strategist at Oppenheimer, said in a note.
Echoing the White House position, as expressed through Treasury Secretary Steven Mnuchin, Stoltzfus blamed programmed trading and “technical factors” rather than “a deterioration in economic and corporate fundamentals” as the reason for the fourth-quarter selling.
In the big picture, Stoltzfus expects the S&P 500 to end 2019 at 2,960. The good news is that represents a 19 percent jump from Friday’s close. The bad news is it’s a hair below the year-end 3,000 target he had for the large-cap index at the start of 2018.
“We believe investors should view this as an opportunity to gain equity exposure at attractive valuations to market segments that appear oversold,” he said.
Indeed, investors can take some solace in that the year ended with a mild Santa Claus rally on Wall Street, albeit under volatile conditions.
The gains bought the major averages up more than 6 percent apiece following the disastrous Christmas Eve dive. However, Stoltzfus, like many of his Wall Street colleagues, believes the market in 2019 will endure some more pain and volatility before finally straightening out and climbing higher.