Stock de­cline may sig­nal turn­ing point

Ex­perts un­sure whether 6.6 per­cent drop a blip or start of a bear mar­ket

USA TODAY US Edition - - FRONT PAGE - Adam Shell

In a span of six treach­er­ous days on Wall Street, the mood of the stock mar­ket has turned from giddy op­ti­mism to gloomy pes­simism.

Pin­point­ing ma­jor shifts in mar­kets is an in­ex­act sci­ence. But some Wall Street pros say the cur­rent one has reached a turn­ing point, as the low in­ter­est rates that pow­ered stocks higher over the last decade give way to higher bor­row­ing costs and height­ened risks.

A swift 1,776 point, or 6.6 per­cent, dive in the Dow Jones in­dus­trial aver­age just a week af­ter it hit a record high shows just how edgy and uncer­tain the in­vest­ing en­vi­ron­ment has be­come.

In­vestors, who a week ago were talk­ing up the mar­ket’s prospects thanks to a strength­en­ing econ­omy, are now notic­ing a wor­ri­some shift in its be­hav­ior.

“Has the mar­ket hit an in­flec­tion point? I think it has,” says Jim Paulsen, chief in­vest­ment strate­gist at The Leuthold Group, a Min­neapo­lis-based money-man­age­ment firm.

This down­turn, he pre­dicts, will likely be more se­vere than the 10.2 per­cent drop the mar­ket suf­fered in Fe­bru­ary. But he’s still not sold on the idea that the break will lead to a bear mar­ket, or 20 per­cent drop, from the mar­ket’s re­cent high.

The de­bate about whether the mar­ket vibe has flipped from bullish to bearish cen­ters on a few key is­sues: They in­clude risks to the econ­omy caused by a rise in in­ter­est rates; trade fric­tions with China; the re­cent drub­bing of tech­nol­ogy stocks; and in­creas­ingly high in­vestor ex­pec­ta­tions that could lead to easy dis­ap­point­ment.

Some Wall Street pros, in­clud­ing Amanda Agati, co-chief in­vest­ment strate­gist at PNC Fi­nan­cial Ser­vices Group, say the re­cent car­nage on Wall Street was long over­due and is a “short-term blip” that will set­tle down

quickly. She stresses that the U.S. econ­omy re­mains strong and the threat of re­ces­sion is low. The mood of in­vestors will brighten, she pre­dicts, when com­pa­nies start re­port­ing their third-quar­ter re­sults.

“I think earn­ings will be re­ally strong and pro­vide an un­der­ly­ing sup­port for the mar­ket and be a pos­i­tive cat­a­lyst,” she says. The cur­rent down­draft has a dif­fer­ent feel than the sell­off in Fe­bru­ary, she adds. That drop was caused by too many in­vestors mak­ing a big bet on the stock mar­ket re­main­ing calm, which back­fired when volatil­ity roared back, catch­ing them on the wrong side of the trade.

Still, oth­ers worry that the mar­ket is en­ter­ing a more dif­fi­cult phase, one that will have a much dif­fer­ent, more chal­leng­ing feel to it.

So what changed in the past week that has in­vestors so wor­ried?

❚ In­ter­est rate angst: The big­gest change has been an ac­knowl­edge­ment that ris­ing in­ter­est rates could cool a strong U.S. econ­omy and also put a dent in cor­po­rate earn­ings. The com­bi­na­tion of the Fed­eral Re­serve hik­ing short-term rates last month and an­other in­crease ex­pected in De­cem­ber, cou­pled with a spike in the 10-year U.S. gov­ern­ment bond to a seven-year high has made stocks less at­trac­tive com­pared with lower-risk bonds.

Low rates and cheap money re­sulted in a flood of money into stocks in re­cent years, as peo­ple searched for big­ger re­turns.

But now fi­nan­cial con­di­tions are get­ting tighter.

“The wave of money that was mov­ing into the mar­ket is now re­vers­ing,” says Savita Subra­ma­nian, head of U.S. eq­uity strat­egy at Bank of Amer­ica Mer­rill Lynch. “As liq­uid­ity is with­drawn from the mar­ket, it am­pli­fies mar­ket volatil­ity” and price swings.

Higher bor­row­ing costs also make it tougher for Amer­i­cans to af­ford houses and buy cars on credit, an­a­lysts say.

❚ Trade war re­al­ity: The pro­tec­tion­ist trade poli­cies of Pres­i­dent Don­ald Trump and his ad­min­is­tra­tion’s tar­iff fight with China have up­ended the long era of free trade. That has un­in­tended con­se­quences, rang­ing from a dis­rup­tion in global sup­ply chains for tech­nol­ogy to higher costs for busi­nesses that ei­ther have to eat the costs or pass them along to shop­pers through higher prices.

“The trade war is no longer ab­stract eco­nom­ics, we’re now start­ing to see it is real-world stuff show­ing up in the earn­ings re­sults of com­pa­nies,” says Hugh John­son, chair­man and chief in­vest­ment of­fi­cer at Hugh John­son Ad­vi­sors in Al­bany, New York.

He notes that com­pa­nies rang­ing from lux­ury re­tailer Tif­fany to auto parts maker Del­phi Tech­nolo­gies have warned that their prof­its will take a hit due to cost pres­sures re­lated to tar­iffs.

❚ Fad­ing tech stocks: Af­ter years of lead­ing the mar­ket higher, fast-grow­ing and in­no­va­tive tech com­pa­nies like Net­flix and Ap­ple have come un­der in­tense pres­sure in the re­cent sell-off, sig­nal­ing that in­vestors are be­com­ing more risk averse and tak­ing a more de­fen­sive stance.

“The sell-off has at­tacked the lead­er­ship of the mar­ket, and that’s a sig­nif­i­cant change,” says Paulsen. “These are the names that most peo­ple own and feel re­ally good about. You are kind of punch­ing in­vestors in the gut where it hurts.”

The tech stock drub­bing, which also has been driven by in­creas­ing fears of reg­u­la­tory scru­tiny from gov­ern­ment amid pri­vacy breaches, shows “in­vestors are get­ting a bit more de­fen­sive,” Agati says.

❚ Ex­pec­ta­tions are high ... too high:

Con­sumer con­fi­dence is at an 18-year high. And small-busi­ness op­ti­mism is at its high­est level since 1983. And why not? The econ­omy’s 4.2 per­cent growth in the sec­ond quar­ter was the fastest in four years, and the na­tion’s job­less rate is near a 50-year low of 3.7 per­cent.

The good times might lift in­vestor ex­pec­ta­tions too high, which raises the risk that in­com­ing good news on earn­ings or the econ­omy won’t be good enough. “That is a higher-risk, lower-re­ward mar­ket,” says Paulsen.

In­deed, all that con­fi­dence can lead to com­pla­cency and dan­ger­ous risk­tak­ing that can lead to bad out­comes, he adds.

“Con­fi­dence re­flects greed,” Paulsen says. “It re­flects com­pla­cency. It leads to be­hav­ior that lends it­self to peo­ple get­ting out over their skis, whether bor­row­ing too much money or get­ting too ex­posed to risky parts of the mar­ket or pil­ing into the pop­u­lar stocks that are work­ing.”



It’s been a rough week for in­vestors on the floor of the New York Stock Ex­change.

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