The biggest single driver of the stock market’s troubles

Understanding what has just driven investors to sell out of their positions usually offers some clue as to what else the market has in store.

What caused the US market to fall out of form at the end of 2018?

The question itself is not merely academic. While forecasting the market often leads to conclusions more wrong than right, understanding what has just driven investors previously to sell out of their positions usually offers some clue as to what else the market has in store.

According to Ian Shepherdson, chief economist at Pantheon Macroeconomics, there’s only one popular explanation for December’s sell-off that investors should still be paying attention to.

First, he disputes the idea that the fading effect of president Donald Trump’s tax cut stimulus has played any significant role in market turbulence.

Shepherdson, however, argues that such a narrative makes no sense. Such an explanation would mean investors failed to realise that the fiscal stimulus was likely a one-shot deal. “The market ought not then to have fallen when an entirely foreseeable event duly happened,” Shepherdson argues.

Next, he points out that fears over a drop in global manufacturing, particularly in China, should not be off too much concern to investors. It isn’t good, but it’s no longer news - especially after yesterday’s grim import data - and the Chinese authorities are now easing policy in response,” he argues.

Meanwhile, concerns over poor home sales in the US, often seen as a harbinger of downturn, is mistaken. “The grim home sales numbers in the final quarter of 2018 were hit by a sequence of three one-time factors, namely, hurricanes Florence and Michael, and the California wildfires. Mortgage demand, by contrast, has risen in recent months, and it leads home sales and housing construction,” he argues.

The key driver behind the sell-off in US equities, Shepherdson claims, was the current trade war. And, with the issue not settled, the outcome of the trade dispute is the key (as of yet) known factor likely to swing markets in 2019.

He argues: “A comprehensive trade deal with China likely won’t return the S&P 500 all the way to its September 20 high, at 2930.

“But we are confident that a substantial rebound in stocks would follow the successful conclusion of the talks, especially if China’s leading indicators start to turn.”

Other investors, though, argue the fading effect of Trump’s tax cuts will prove influential in the year ahead.

Andrew Milligan, head of global strategy at Aberdeen Standard Investments, points out this week marks the start of a deluge of company reports as the fourth quarter earnings season opens up for S&P 500 members. Analysts are forecasting overall profits to grow about 15% year-on-year in the fourth quarter, with some sectors, like energy and industrials, exceeding that.

Milligan points out that much, but not all, of this is due to the sugar rush from President Trump’s tax cuts which propelled earnings growth towards 25% in recent quarters.

He adds that while the ‘sugar rush’ is starting to fade, the key question is how quickly such growth falls away in 2019.

“This will not be a stellar earning season. But it will be an influential one. The best of the gains of the Trump tax cuts are behind us and the outlook for companies is fogged by a number of big uncertainties. The risk is that firms use the recent selloff to lower the bar for next year, which would be worrying,” he says.

“There is sufficient momentum to deliver decent profits growth for the time being, and when investor sentiment has been so depressed even a modicum of good news can encourage risk averse investors to put cash to work.”

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