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Outlook for 2019: Stock market corrections aren’t always followed by recessions

Expect more stock market volatility in the new year but investors might just dodge a recession, experts say.

Trader Peter Tuchman on the floor of the New York Stock Exchange last week. Stocks capped off a losing year on Monday.
Trader Peter Tuchman on the floor of the New York Stock Exchange last week. Stocks capped off a losing year on Monday.Read moreRichard Drew / AP

Many people felt sick after the stock market turmoil of 2018. Will 2019 treat investors any better?

Most probably, according to professional investors pointing to similar episodes in 2001, 1987, and as far back as 1962 — that is, market corrections that did not lead to a recession.

That’s the expectation among experts polled by the Inquirer who follow stocks and bonds closely.

There’s no doubting that the year’s close was harrowing and that some key economic indicators are darkening. The advance on Friday trimmed the worst December rout for the S&P 500 since 1931 to 9.2 percent. That monthly rout capped a 6.2 percent slide in the year for the S&P, the biggest of the record bull market. The Dow fell 5.97 percent for the year, while the Nasdaq dropped 4.38 percent.

“Financial markets have finally awoken to the fact that Donald Trump is U.S. president,” Nouriel Roubini, an economist widely credited with predicting the 2007 financial crisis, wrote this week. “Many trusted that, at the end of the day, the ‘adults in the room’ would restrain Trump. … Things changed radically in 2018.”

So what led to all the turmoil leading into 2019? The reasons were myriad. A U.S.-China trade war, Facebook’s Cambridge Analytica scandal, Brexit, and Italy’s out-of-whack budget all helped set the table.

General Electric was dropped from the Dow Jones index, and retailer Sears continued to collapse. The European central bank proclaimed the end of bond buying; the Federal Reserve raised interest rates. The Trump Administration kept hemorrhaging advisers and the president kept attacking the Fed even as international problems intensified. And most recently, the U.S. government was shut down.

But there were plenty of bright spots too: American unemployment dropped to historic lows, Congress passed a revamped tax code that dramatically lowered corporate taxes, and a new NAFTA pact solidified trade with Canada and Mexico. Cannabis stocks went on a tear, electric and self-driving vehicles entered the early years of a revolution, and Amazon announced two new headquarters.

So now what? Expect moderately good news, according to Bill Stone of Houston-based Avalon Advisors. On average, investor returns were positive three months, one year, and three years after buying into a 20 percent decline — even if the decline ended up continuing further, said Stone, PNC’s former Asset Management chief investment strategist.

And while Stone thinks volatility will likely persist and could even worsen, he doesn’t see a recession in the near-term.

“The risk of recession remains low over the next 12 months although U.S. growth is certainly slowing. With return to a more normal monetary policy, along with a slowing global economy and trade disputes, it seems likely that volatility will persist, so be prepared for the roller coaster ride to continue and perhaps even take us back below the recent low," Stone wrote in a Monday note to clients.

Armed with these facts, he believes that investors should consider at least rebalancing their portfolios and invest more in stocks "as this decline has likely provided an attractive entry point, especially if the U.S. avoids recession as we expect,” he added.

“Is the fundamental economy strong? The answer is yes. the market will follow,” agreed finance professor Charles Elson, head of the University of Delaware’s John L. Weinberg Center for Corporate Governance. Elson holds a faculty chair endowed by former DuPont Co. chairman Edgar S. Woolard Jr.

“We can’t look at the market on a month-to-month basis, but only on a longer period. The Trump tax cut did what it was supposed to do. It stopped companies reincorporating overseas. And the tax reform enabled companies to return more to investors, and invest in capital projects which they’d put aside," he said.

Elson said the late 2018 market correction “reminds me of 1981-1982, when the market came back after tax cuts. … And in 1987, we had a stock market correction without a recession."

Economist and market strategist Ed Yardeni of Yardeni Research found similar data going back to the 1940s.

Elson is also optimistic that the trade war with China will be resolved in 2019, contending that “Trump stakes out extreme positions and ultimately forces a resolution like he did in Europe.”

The big wild card? The Fed, Elson said. Fed chairman Jerome Powell has signaled two more short-term rate increases in 2019, which some investors argue are not warranted.

“What does the central bank do with rates?" Elson asked. "The Fed has huge impact on the direction of the economy, so will they kill off a recovery?”

A steep market decline doesn’t necessarily mean that a recession is coming. Since 1929, there have been bear markets 20 times, according to data compiled by Charlie Bilello, head of research at Pension Partners. Eleven have been followed by a recession.

But deep and lasting market declines tend to make businesses and consumers afraid, and they pull back on spending, which is how the market can spill over into the economy and cause damage. There are early indications that is starting to happen: Consumers, who power the U.S. economy with their spending, are growing more uneasy about the future.

The Conference Board’s Consumer Confidence Index dropped in November and December. And retail investors are the most gloomy they have been about stocks in more than five years, according to the American Association of Individual Investors’ survey released before the holidays.

While consumer spending has been strong this holiday season, businesses are showing signs of paring back their spending as they see signs of duress. Nearly half of chief financial officers think the U.S. economy will be in a recession in a year, according to the Duke University/CFO Magazine Global Business Outlook survey.

Still, the current decline in stocks spells opportunity for some. Pennsylvania Trust told its clients that the S&P 500 now is trading at “reasonably attractive valuation levels,” or about 15 times 2019 consensus earnings estimates. While earnings growth will slow markedly in 2019, S&P 500 companies are still expected to show 7 [percent] to 8 percent earnings per share growth on 5 [percent] to 6 percent revenue growth."

According to Barron’s, the mean 2019 forecast of Wall Street strategists for the S&P 500 is 2,975, up from current levels at just over 2,500. Outliers included JPMorgan, which forecast the S&P 500 to hit 3,100 next year.

The Washington Post and Bloomberg News contributed to this article.