The Stock Market’s Dangers Are Easier to See Now

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.”

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.

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