Stock Market Forecast For 2019: 7 Critical Trends To Watch

The new year begins with a gnawing question: Is the stock market correction of the past three months a harbinger of an awful 2019, or a launchpad for a new bull market? While it’s folly to make a decisive stock market forecast for 2019, a few trends hold clues.

On the face of it, financial markets seem to sense trouble. On Christmas Eve, the S&P 500 index hit the 20% threshold for a bear market.

Few experts see a recession, but signs of slowing economic growth are piling up. The 10-year Treasury yield has fallen to the lowest since April, even as the Fed tightens and unwinds its quantitative easing program.

The financial sector is in a bear market, with the SPDR Financial ETF (XLF) down more than 20%. The price of crude oil is in a bear market, too, as a supply glut meets worries of a slowing global economy. The FAANG stocks that underpinned much of the stock market’s 2017-18 gains are trashed. And the market lacks clear new leadership. The IBD 50 index of leading growth stocks is off nearly 30% from its high.

So how to judge the year ahead? As always, smart investors will keep their eyes wide open to the stock market’s actual behavior at any point in time. But seven factors loom large for the stock market forecast for 2019. How they play out will play a huge role in how stocks perform.


2018 Stock Market In Review (PDF)


Of all these factors, two stand out because of their unpredictability and consequences: trade policy and interest rates. The trade war can expand suddenly into multiple industries and cause spillover effects. Markets fear Fed rate hikes will overshoot, sending the economy into recession.

Here’s a look at each of the seven factors, plus tips on how stock market investors can prepare for whatever 2019 brings.

1. Stock Market Volatility

For much of 2018, the stock market tolerated a trade war, Treasury yield anxiety, Europe’s political spasms and other risks. In the final months of the year, investors could bear it no longer. As 2019 begins, the market has to pick itself up from the worst correction since 2011. On Dec. 20, the Nasdaq sank to a bear-market depth.

Volatility underscored much of the 2018 market. Based on daily price swings, 2018 had double the volatility of the unusually placid 2017. But it was below average in terms of price spreads and just slightly above average in change, according to market history going back to 1962. The last three months, though, have been well above average, which is typical with bear markets.

IBD’s current outlook for the stock market is “market in correction,” urging investors to stay in cash as much as possible. Stock opportunities remain scarce. Few leading stocks are forming sound bases, and scores of breakouts over the past few months have floundered. Investors will need to be patient and wait for a bottom.

With the S&P 500 index up about 135% since its 2009 low, it felt like living near California’s San Andreas fault: The more time that passed, the closer we got to a major shaker. But just like it’s necessary to relieve pressure on the earth’s tectonic plates, it’s necessary to wring out excess speculation from time to time.

A bear market or even a big correction serves a useful purpose by removing excess froth. Lofty price-earnings multiples come down and a fresh wave of institutional buying sparks the next bull market. Major stock market declines usually form three down legs, and indexes today are in their third retreat since the top.

While the stock market hasn’t been this bad in years, there are no signs that a super bear market of the kind in 2008 or 2000 is imminent. Mega declines happen when there’s extreme overconfidence. For example, margin debt surged to levels unseen since 2000 before the market top of 2007. Margin debt growth is barely a blip right now.

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2. World Stocks Vs. U.S. Stock Market Forecast For 2019

Much of the stock market forecast for 2019 depends on the strength of economies in the U.S. and abroad. As bad as the U.S. stock market ended 2018, it still outperformed most major world indexes. And the same could happen in 2019.

While the S&P 500 is down about 7% for 2018, the Shanghai composite is off 25%, the Shenzhen 33%, France’s CAC 40 13%, Germany’s DAX 20%, London’s FTSE 100 15% and Japan’s Nikkei nearly 12%. Brazil and India, however, are up 12% and 5%.

U.S. economic performance was much stronger and corporate profits much higher than in other developed countries, even after stripping out the boost from the U.S. tax cut, says Kelly Bogdanova, vice president and portfolio analyst at RBC.

“It’s very clear that we are still seeing economic challenges in Europe and Asia, including China, and China is a very important factor,” Bogdanova said. Political issues in Europe are compounding matters for the 2019 outlook.

Central banks are another big factor to watch. While the U.S. and Canada have tightened, monetary policies in Europe and Japan remain largely accommodative.

IHS Markit estimates eurozone growth of 1.5% in 2019, down from 1.9% in 2018.

The U.S. economy is expected to continue expanding, albeit more slowly. RBC forecasts U.S. growth at 2.5% next year, in line with most other forecasts. U.S. GDP growth is estimated at 2.9% this year, the highest since 2005, BMO Capital Markets said in its 2019 outlook.

In fact, the U.S. economic expansion is on track to become the longest on record by next summer. A Blue Chip poll found that professional forecasters put the odds of a U.S. recession in the coming year at 24%, BMO said. The lower the chance of recession, the less likely the market will stay in bear territory.

3. Trump Tariffs And China Trade War

The U.S.-China trade dispute is putting pressure on the global economy and the stock market itself, RBC’s Bogdanova adds. It forces companies to put off capital decisions, and uncertainty overall grows for executives.

The trade war threatens to intensify China’s woes, Bogdanova says. But Beijing has some levers it can use to stimulate its economy, and she expects China will resort to them in 2019.

For now, the U.S. and China are in a 90-day trade war truce while they negotiate an agreement in what’s become a centerpiece of President Trump’s administration.

Unlike corporate profits and monetary policy, international trade requires diplomacy. That’s why it is a hard risk to evaluate when assessing the stock market forecast for 2019.

“We believe an escalating trade war with China could have a significant direct impact on S&P 500 profits,” JPMorgan warned in its 2019 outlook, echoing other forecasts. An escalation could create indirect costs depending on the extent of Chinese retaliation and the toll on business confidence and the global economy.

A strong dollar has helped shield U.S. businesses and consumers from the effects of tariffs, BMO Capital Markets Senior Economist Sal Guatieri noted in a report. The “tariff toll” on GDP is likely to be limited to 0.4%. On top of that, he said, “Due to slower global demand and the trade-weighted dollar’s 8% rise this year to 16-year highs, a further widening in the already decade-large U.S. trade deficit is expected to carve 0.5 (percentage points) from growth in 2019.”

4. Fed Rate Hike Outlook

How Federal Reserve policymakers handle interest rates is a big question mark in the stock market forecast for 2019. The Fed raised interest rates four times in 2018. On Dec. 19, policymakers signaled two more Fed rate hikes in 2019. That’s down from an original forecast of three Fed rate hikes. But Wall Street expected a more dovish tone, and stocks plunged.

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Yet markets still seem skeptical that tightening will continue. The 10-year Treasury yield is trending lower, and the Cboe’s FedWatch shows traders expect no rate increases at all in 2019.

Near-record low unemployment and other bullish indicators have given the Fed justification to raise borrowing costs. Rising rates pressure profit margins and earnings.

Perhaps more worrisome than Fed rate hikes is the partial inversion of the Treasury yield curve, something that has a good track record of predicting recessions.

The difference between the 2-year and 10-year Treasury yields has narrowed to about 20 basis points. Once the 10-year yield is lower than the 2-year, historically a recession is likely.

While that hasn’t happened yet, in early December the spread between 3- and 5-year Treasury yields and the 2- and 5-year yields turned negative. The last time that happened was in July 2007. Four months later, the stock market topped and the Great Recession began.

However, inversions at the short end of the Treasury yield curve aren’t great predictors of recessions, says LPL Financial Research.

The better indicator is the inversion of the 1-year and 10-year Treasury yields. Research from the San Francisco Fed shows these inversions signaled all nine recessions going back 60 years.

Keep in mind that the signals have considerable lag.

“Contrary to what many people think, inverted yield curves don’t always sound the alarm to sell,” LPL Research Senior Market Strategist Ryan Detrick said in a Dec. 5 report. “In fact, looking at the past five recessions, the S&P 500 didn’t peak for more than 19 months, on average, after the yield curve inverted.”

In the past two tightening cycles, however, the Fed went too far, which led to recessions in 2000 and 2008.

“The yield curve believes the Fed has already done their job with inflation,” said Christopher Hyzy, chief investment officer of Merrill Lynch. “When has the yield curve been wrong?”

5. Small Caps And Stock Market Forecast For 2019

Small-cap stocks can be an important fuel for the overall market. But in late 2018, they led Wall Street’s slump. Will they continue to be a drag?

In 2019, small-cap growth companies face some uncertainty. Valuations for growth small caps are stretched compared with value small caps, says Scott Hood, CEO of First Wilshire Securities Management, a Los Angeles-based firm that specializes in small-cap investing.

“We are currently at the largest price/earnings valuation gap between Russell 2000 Growth over Russell 2000 Value since 2003,” Hood said. The Russell 2000 Growth has a median price-to-book value of 4.5 versus 1.8 for the Russell 2000 Value index.

“There has been too much excitement built into growth stocks. It came to a stage where stories were driving the market such as Bitcoin, cannabis and the great search for the unicorn,” he told IBD.

The profit picture for small caps isn’t so rosy either. By First Wilshire’s calculations, 37% of the Russell 2000 have negative trailing earnings. It’s 39% for the Russell 2000 growth index.

Factoring in all that, 2019 could shape up to be a stock picker’s market in small caps, requiring investors to choose their stocks carefully.

6. 2019 Earnings Growth

Earnings are the catalyst that can drive stock prices higher. S&P 500 earnings growth accelerated in 2018, thanks in large part to the Trump tax cuts.

But how do earnings play into the stock market forecast for 2019? Comparisons will be tougher. Plus, as companies reported strong third-quarter profits, they began significantly lowering Q4 and 2019 estimates.

FactSet estimates 2018 earnings will surge 20.3%, which would be the best growth since 2010. An estimated 8.9% revenue increase would be the highest since 2011.

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For 2019, FactSet’s calculations put S&P 500 earnings growth at only 7.9% with 5.3% revenue growth. A tight labor market, rising raw materials and higher financing costs could squeeze U. S. companies, but it remains to be seen how much. A strong U.S. consumer should be able to absorb higher prices if companies try to pass on costs.

Corporate earnings growth probably reached a peak in 2018, David Bianco, head of U.S. equities and DWS chief investment officer, said in a Nov. 26 note. “As this fiesta was mainly due to special effects such as tax cuts, dollar repatriation and rising oil prices, it is no surprise that the party cannot go on,” he said.

7. IPO Calendar For 2019

Initial public offerings can introduce hot new stocks to investors and invigorate the market. And 2019 is expected to see some major brands make initial public offerings and attract capital.

“After years of IPO rumors, Uber, Lyft and a large backlog of other unicorns are firmly indicating plans to complete some of the largest-ever IPOs,” gushes the Renaissance Capital annual review. The firm, which specializes in IPO stocks, estimates the Uber IPO could raise more than $13 billion and the Lyft IPO more than $5 billion.

Other large IPOs in the pipeline are social pinboard platform Pinterest, collaboration software company Slack, exercise bike company Peloton Interactive and free-stock-trading app Robinhood. As in 2018, technology and biotech companies dominate the 2019 IPO pipeline.

Proceeds from IPOs could easily top the $47 billion raised in 2018, despite a potential decline in the number of deals, Renaissance Capital says. The same risks that brought the stock market down could put the number of 2019 IPOs in the range of 125 to 200 companies, compared to 190 this year.

The 2018 IPO market saw a 19% rise in IPOs with a 32% increase in proceeds. But overall, it was a bad year for IPO stock performance. As of Dec. 13, the Renaissance IPO Index was down 10.8% for the year, lagging the S&P 500’s 1% rise. The average total aftermarket return for 2018 IPOs was -10.5% — way down from 14.3% and 13.2% returns the previous two years.

What Should Stock Investors Do Now?

Of course, the stock market will need more than just a few blockbuster IPOs to get back on track. The surest signs will not come from the IPO market or Washington but the stock market itself.

Investors need to watch daily how the major stock market indexes are acting, which sectors are rebounding and which stocks form good bases. Just like the market signals its tops, it will also signal when it’s reaching a bottom and may do so even when all the news seems to be negative. Read The Big Picture and Stock Market Today columns to stay abreast.

Keep an eye on stocks with good earnings and sales growth that are performing better than the overall stock market. Such stocks could become the early leaders in the next upturn and go on to big gains.

As 2018 concludes, some software leaders are shaping up as potentially good investments. Atlassian (TEAM) is forming one of the most attractive bases. Five9 (FIVN) has traded mainly above its 50-day moving average while it bases.

In finance, PayPal (PYPL) has held firm at lows around 75. In the consumer space, Planet Fitness (PLNT) harnessed its latest decline to a moderate 17%. And in health care, sleep apnea treatment maker ResMed (RMD) is shaping a decent cup with handle.

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