Stocks are at record levels but there are two big problems ahead for investors

Brian Sozzi
Editor-at-Large

It’s great to be two things right now: alive (always a good thing) and an investor in the stock market.

But a cautionary reminder, don’t get complacent.

Despite the ever present fear of a bad Trump tweet on the trade war with China that could instantly roil the psyche of the market, stocks have enjoyed one heck of a record-setting run since October. Kudos to cyclical-minded industrials and financials for leading the headline grabbing gains. Cyclical sectors have seen strong inflows of $3.5 billion since October 4, points out investment bank Jefferies. On the other hand, safe-haven bond proxies have seen outflows of $1.1 billion.

The overall price-to-earnings ratio for the S&P 500 has expanded to its highest level since January 2018 during this impressive stretch, notes Bank of America, even while Wall Street’s earnings estimates have fallen. Hat tip to the Federal Reserve and its three rate cuts this year for that P/E expansion, with a mild high-five to what may be a yearend phase one trade deal between the U.S. and China.

But amidst the feel good vibes on the Street ahead of the holidays, the market may be forgetting at least two near-term downside risks to stocks.

The first is continued lame U.S. economic growth.

The market has been bid up on the notion that U.S. economic data bottomed over the summer, most importantly in the manufacturing and labor market areas. “Given that the [October manufacturing] surveys were previously pointing to negative growth, however, the October rebound does at least provide further reassurance that the economy isn’t plunging into recession,” writes Capital Economics U.S. senior economist Andrew Hunter.

Reassuring. That doesn’t mean, however, growth in the fourth quarter or into 2020 will be of the rip-roaring type that justifies stock valuations at almost two-year highs. In fact, Hunter thinks the U.S. economy will slow further in the fourth quarter from the 1.9% rate in the third quarter.

Expect a slowdown

Hunter isn’t alone in worrying about ongoing slow economic growth.

Pimco portfolio manager Erin Browne thinks U.S. economic growth will slow to a meager 1% over the next couple of quarters.

“Some of the global growth slowdown is still going to be felt through the U.S. economy over the next couple of quarters. We do think there is a persistent drag being driven by the trade headlines that we saw earlier this year until a couple of weeks ago,” Browne said on Yahoo Finance’s The First Trade.

And that brings us to problem two.

The Federal Reserve has strongly hinted that it’s done cutting interest rates in the near-term. And the signal has not been lost on Wall Street. There is currently a 96.3% probability the Fed leaves interest rates unchanged at its final meeting of the year on December 11, according to the CME FedWatch Tool.

Browne believes the Fed is likely done with rates for the time-being, but thinks there is a possibility for one more cut in early 2020.

“The Fed is in a wait and see mode,” Browne says.

That’s all fine and dandy. The market, however, will be losing a stimulus element into yearend at a time where economic growth is likely to be stagnant and trade deal headlines voracious.

So enjoy the rally. Be mindful though that nothing lasts forever.

Brian Sozzi is an editor-at-large and co-anchor of The First Trade at Yahoo Finance. Follow him on Twitter @BrianSozzi

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