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We just got a look into the future for investors

Myles Udland
Markets Reporter

Even with just four days of trading, this past week was a headache for investors.

The Dow lost 4.5%, the S&P 500 dropped 4.6%, and the Nasdaq dropped 4.9%. For each of the major indexes, it was their worst week since March .

And for some market experts, this marks only the beginning of a rocky period for investors that will continue.

“We think that this week’s turbulence provides a reasonable guide to the trends to watch for in markets next year,” said Oliver Jones, markets economist at Capital Economics. “In particular, while both the S&P 500 and U.S. Treasury yields have started to drop a little sooner than we had previously anticipated, we still suspect that both have much further to fall in 2019.”

As of Friday’s close, the S&P 500 was off 1.5% for the year, while Treasury yields are still up sharply from where they began the year, with the 10-year finishing the week at 2.845% after starting 2018 at around 2.45%.

Jones notes that while incoming U.S. economic data remain solid — the November jobs report and the ISM’s latest reading on service sector activity were solid — “markets are forward-looking, and the broad-based nature of the decline in the S&P 500, as well as the flattening of the Treasury yield curve, point to worries about the prospects for the economy, which we think will get worse in 2019 as growth does indeed falter.”

This past week of market action gave investors a look into the future, according to some strategists. (AP Photo/Ted S. Warren)

Jones is not alone in the view that 2019 will not just provide a more challenging year for investors, but represent the beginning of an outright decline in the stock market. Savita Subramanian, a strategist at Bank of America Merrill Lynch, said in a note to clients last month that, “in 2019, we see elevated likelihood of a peak in the S&P 500.”

“Our rates team is calling for an inverted yield curve during the year, homebuilders peaked about one year ago and typically lead equities by about two years and our credit team is forecasting rising
spreads in 2019,” Subramanian added. “Assuming the market peaks somewhere at or above 3000, our forecast is for modest downside in 2019.”

Subramanian’s year-end 2019 target is 2,900 for the S&P 500, but her team currently forecasts the benchmark index getting to 3,000 before rolling over. On Friday, the S&P 500 closed at 2,633.

For investors right now, the biggest driver of recent market action has been trade. Markets rallied at last Sunday evening’s futures re-open following the G-20 meeting in Buenos Aires between President Donald Trump and Chinese President Xi Jinping. This rally fizzled amid both a “sell the news” inertia in markets — recall that the S&P 500 had its best week in seven years last week — and messaging out of the Trump administration which included Trump tweeting he is a “ Tariff Man .”

And this all came before the arrest of Huawei CFO  Meng Wanzhou in Vancouver appeared to put the entire trade truce at risk. Meng is not just the CFO of Huawei, but the daughter of the company’s founder. Additionally, Meng was arrested on December 1, the day of the U.S.-China meeting last Saturday at the G-20 meeting.

On Sunday morning, Bloomberg reported that Terry Branstad, U.S. ambassador to China, had been summoned by China’s foreign ministry, another sign of the continued fallout from the tentative G-20 agreement and Meng’s arrest.

“While China may stomach fines, investigations, and market restrictions against its national champion, we do not believe it will tolerate the arrest of a CFO, even if she were not the daughter of the founder,” said Laban Yu, equity analyst at Jefferies in a note this week.

“Given the chaos of this White House, we would not be surprised if high pressure tactics of ‘going after’ Huawei misfired due to communication lapses and bureaucratic inertia. If so, we believe the U.S. (and Canada) have limited time to rectify the error. If not, the trade negotiations are in serious jeopardy, in our view.”

And indeed, corporate America has been most acutely focused on the challenges that trade tensions present. In a note to clients published Friday, Dubravko Lakos-Bujas and the equity strategy team at J.P. Morgan noted that trade concerns have by far been the biggest topic of discussion by corporate managements during earnings conference calls.

Trade concerns have been far and away the biggest topic of conversation by management teams during corporate earnings calls. (Source: J.P. Morgan)

Lakos-Bujas and the J.P. Morgan team, however, expect that trade tensions will be resolved, presenting investors with healthy potential upside in the stock market from current levels. The firm’s year-end 2019 price target for the S&P 500 is currently 3,100 with earnings set to rise 8% in 2019.

“The largest source of risk to this earnings view is linked to tariff uncertainty via potentially higher input costs and profit margin compression,” J.P. Morgan writes. “Our working assumption remains that there is greater probability of a trade deal than tariff escalation, given incremental progress at the G20 meeting between US and China.”

The recent news flow around trade and the market’s skepticism regarding declarations from the Trump administration about how well talks are going with China suggests a bet on de-escalating the U.S.-China trade war is becoming a less likely proposition. However, if trade appears to be less likely to find a resolution, the upside opportunity for investors expands in the event trade tensions are resolved.

Myles Udland is a writer at Yahoo Finance. Follow him on Twitter @MylesUdland