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A 'catastrophic' market crash could come in 2020 if this indicator turns surprisingly south

The U.S. jobs market has to stay solid in 2020, or it could be look out below for the red-hot stock market.

That’s especially so in the first half of the year following the late 2019 market melt-up that has descended on the Nasdaq Composite, Dow Jones Industrial Average and S&P 500.

“U.S. equities are slightly overpriced, but there is still reason to be long,” CME floor trader Bob Iaccino told Yahoo Finance. “[But] if you see any sort of employment weakness in January and February, that could be a catastrophic crash for the equity markets.”

Iaccino says many institutional traders have begun to sell equities into strength, and nibble at some put options — a tell-tale sign of fear the rally (for whatever reason) will take a breather early on in 2020. When someone buys put options, it’s a wager a stock price or index will decline.

The logic behind Iaccino’s market call is strong, even if a “catastrophic” plunge in stocks is unlikely should the job market make a tepid start to 2020.

One of the surprising stories of 2019 is how resilient the U.S. labor market has stayed amid rising uncertainty in Corporate America that has hurt capex spending and impacts to profits from the China trade war. Employers added an average of 193,000 jobs per month in the third quarter. November’s gain clocked in at an impressive 266,000, while October’s figures were revised higher by 28,000.

The unemployment rate is hovering near 50-year lows.

Such labor market resiliency and three rate cuts this year from the Fed have poured gas on the 10-year-old bull market in stocks.

High expectations

Investors currently expect this one-two punch of low rates and a solid labor market to buoy consumer spending next year (as seen in stocks trading above historical valuations), so any deviation from it will likely be met with swift profit-taking. Sentiment in the market would probably shift to a view the Fed is running out of bullets on the rate cut front (never viewed favorably) and the economy is not snapping back as quickly as had been priced into stocks.

As for the driver of any possible labor market letdown to kick off 2020, look no further than capex spending. Business investment declined by a 1% pace from the second quarter to the fourth quarter, strategists at Goldman Sachs have pointed out. The market presently believes capex spending is poised to accelerate in 2020 following the U.S. phase one trade deal with China. But that is hardly a given as we enter an election year and trade conditions between the Trump administration and key partners are hardly ideal.

In other words, improved capex spending by companies is an ultimate show-me story right now.

“A deeper economic slowdown is another risk to consider. There has been a pause in the U.S.-China trade conflict, but any material escalation of global trade disputes could undermine market sentiment and cut short the expected manufacturing and capex recovery that underlies our tactical views,” cautions BlackRock vice chairman Philipp Hildebrand.

To be sure, Iaccino’s mention of a catastrophic decline in stocks should jobs disappoint is the minority view on Wall Street entering 2020.

Most big bank strategists are modeling for a year of low-single-digit gains for stocks underpinned by low interest rates and a healthy employment market. For its part, Goldman Sachs expects U.S. real GDP to accelerate to about 2.4% in 2020 from 2.2% in 2019. Strategists at Goldman expect the labor market to deliver an average of 156,000 job gains a month, and the unemployment rate to drop to 3.3% from 3.7% this year.

So if you are long the market, pray for 156,000 job gains a month.

Brian Sozzi is an editor-at-large and co-anchor of The First Trade at Yahoo Finance. Follow him on Twitter @BrianSozzi

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