If financial advisors attending this week’s Schwab Impact 2018 conference in Washington were hoping for reassurances that the recent rout in U.S. and global stock markets was temporary, they were probably disappointed.
Two top Schwab strategists and another from Horizon Investments all offered sobering outlooks for the U.S. and global stock markets.
Jeffrey Kleintop, Schwab’s chief global strategist, said the recent drag on U.S. and global stock market indexes could fade over the next three to six months but face increasing pressures afterward.
Over the next six to 18 months, the U.S. economic cycle could peak — as indicated by unemployment rate matching the inflation rate — and the yield curve could flatten, then invert after several more rate hikes by the Federal Reserve. (Kleintop focuses on the gap between 10-year Treasury notes and three-month Treasury bills, which is currently 78 basis points, down from 131 basis points a year ago.)
Both developments typically signal a recession coming about one year later, said Kleintop. He doesn’t expect another crisis like the one in 2008, but a “garden variety bear market recession,” one that’s not limited to just the U.S. but also includes other developed and emerging markets.
Liz Ann Sonders, Schwab’s chief investment strategist, noted that the risk of a recession in the U.S. is currently low but rising and is higher outside the U.S.
Contributing to rising risks in the U.S. are growing trade tensions between the U.S and China, which could worsen if the U.S. imposes tariffs on $500 billion worth of Chinese imports, as the White House has proposed. That would essentially double the amount of imports subject to tariffs and could cut a full percentage point from U.S. GDP, said Sonders.
She cautioned against relying too much on current economic data, such as consumer confidence at an 18-year high, which looks great now but is a typical characteristic of market peaks. “Recession is a risk we have to be mindful of.”
In addition, Sonders said stocks are likely to come under pressure from rising rates — “valuations tend to fall when rates are rising regardless of earnings”; rising Treasury yields — the 2-Year Treasury yield is well above the S&P dividend yield at 2.8% vs 1.9%; and the “rolling off of the tax reform burst, which had “juiced earnings.”
The upcoming midterm election is another pressure for the stock market, according to Sonders. She said the average drawdown in U.S. stock market during midterm election years tends to be 17% from peak to trough. (The decline year to date is about half that.)
Greg Valliere, chief global strategist at Horizon Investments, said the most likely result of the midterm election is a Democratic House and Republican Senate, which means gridlock in Washington.
He has “no hope for an imminent deal with China” on trade, which is beginning to hurt U.S. businesses and could slow growth, and said President Donald Trump’s bashing of the Fed and the U.S. dollar is not helpful for markets or the economy. Nor is the $1 trillion deficit, which is expected to continue over the next eight to 10 years, according to Valliere.
“No one in D.C. cares about the budget deficit. No one is talking about deficit reduction, but when debt servicing costs rise over the next decade, it will be a problem.”
— Check out Schwab’s Clark Pats RIAs on the Back for Helping Clients Through Financial Crisis on ThinkAdvisor.