Perfect Storm Threatens Bull Market after Rallies on Fed, Trade Talks

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Perfect Storm Threatens Bull Market after Rallies on Fed, Trade Talks

Stocks have surged to within a hair’s breadth of all-time highs as investors anticipate Fed rate reduction and a US-China trade agreement. However, numerous market experts believe that these gains are likely to be false and fleeting. Instead, a perfect storm is brewing that could hammer equity markets in the second half of the year, as four major headwinds gather strength, including weaker-than-expected earnings, a halt to massive stock buybacks, fewer-than-expected rate cuts, and growing turmoil from Brexit and other European convulsions, according to macro strategist David Deluard at INTL FCStone, as detailed in a Business Insider story.

“Rate reduction, a relatively resilient economy, a strong earnings beat rate, and the recent downturn in prices will persuade some investors to buy the dip,” Deluard said in a client note. “However,” he warned, “stock market falls will resume in the autumn, with a perfect storm of unfavorable circumstances.”

Deluard is not the only one who is skeptical. According to senior investment strategist Michael Hartnett, a Bank of America Merrill Lynch poll reveals investor pessimism is at its highest level since the financial crisis ten years ago, “with pessimism fueled by trade war and recession worries.” Morgan Stanley analysts warn the danger of a recession and a major market drop has risen dramatically.

These negative expectations come after the main indices achieved big gains in June and rose again on Tuesday in anticipation of a U.S.-China trade agreement. The latest trigger was the announcement that President Donald Trump would have a “extended meeting” with Chinese President Xi Jinping at the G-20 summit next week.

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What it Means for Investors

The biggest danger is that any trade agreement between the United States and China falls significantly short of market expectations, or that the war continues. According to macro expert Deluard, ongoing trade tensions threaten reducing corporate profit margins. If those margins do not improve, investors should brace themselves for weaker forward guidance in Q2 earnings releases, or be surprised by lower-than-expected profits in Q3 and Q4. In the past, downward profit adjustments have been damaging to stock values.

Furthermore, Deluard claims that stock buybacks, which have played a significant role in boosting the stock market, will be curtailed during earnings ‘blackout’ periods, when corporations prevent the purchase of their own stock. While this delay happens every year during the results season, increased trade tensions and the waning effectiveness of Trump’s tax cut might amplify the ‘blackout’ effect.

While markets are presently valuing up to three rate cuts, Deluard feels that the current pace of inflation justifies two cuts. If the Fed fails to match market expectations, anticipate stock prices to fall.

Within Europe, Deluard believes that several factors, including how the European Commission handles Italy’s “excessive” deficit, the expiration of Mario Draghi’s term as president of the European Central Bank (ECB), and the very real possibility of a “no-deal” Brexit, could destabilize the stock market.

Looking Ahead

Morgan Stanley’s new bear-case estimate paints a dismal picture if the trade war between the United States and China worsens. Morgan Stanley predicts the S&P 500 to fall to 2,400 in the next six to twelve months, the US economy to enter a full-fledged recession by 2020, and profits growth to reach a trough of minus 14% in 2021 in the 20% likelihood that this scenario unfolds.

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