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Why the stock market is one or two bad economic reports away from a collapse

Brian Sozzi

Investors need to wake the hell up.

Just because the market is “holding up well” during the past month or so of dreary trade war headlines doesn’t mean everything is fine and dandy. The signs are starting to build that the global economy is cooling down more quickly than many balding pundits and aging stock price predictors would have investors to believe.

Consequently, valuations on stocks are well overdue for a significant haircut. Not the drip, drip, drip BS investors have endured the past month — the S&P 500 and Dow Jones Industrial Average are “only” down 3.8% and 4.1%, respectively, since late April.

Think 10% nosedive, or more. In other words, a classic collapse.

“Of course, some people could argue that the S&P 500 holds up very well in the face of this news [trade, etc.]. Well, this is true, but we also have to note that when the 20% decline began in October, the S&P was down only 5.2% after three weeks,” Miller Tabak strategist Matt Maley reminds everyone.

Supremely put.

Ignore the signs at your own risk

Investors entered thepost Memorial Day long weekend oddly still feeling pretty good. The Dow just capped off its fifth straight weekly loss, the first time that has happened since 2011. Yet, there remains this hope the market rally will soon return and the declines of late are normal given the uncertainty around global trade.

To many, the Federal Reserve is a friend and the U.S. jobs market is humming along — both serving as powerful reasons for stocks not to stay on the mat for too long.

Going lost in this rose-colored glasses backdrop is mounting evidence that the trade war is taking its toll on companies around the world. In turn, economic data and leading areas of the market are worsening.

Some noteworthy points from the battle trenches:

  • The flight to safety has continued — the 10-year Treasury yield is at its lowest since October 2017.

  • The yield curve inverted again on May 23. Recall from last year that this is often viewed as a reliable recession indicator.

  • IHS Markit U.S. manufacturing PMI for May badly missed Wall Street estimates and fell month over month. Sentiment among manufacturers hit its lowest level in nine years.

  • The April reading on durable goods softened across the board.

  • Copper prices are down 8.9% the past four weeks.

  • The Dow Transports and small-cap Russell 2000 have underperformed the S&P 500 and Dow the past month.

“It just seems to us that the level of uncertainty has gone up dramatically over the past 3 weeks... and this uncertainty is not going going to calm itself soon,” Maley contends.

“What surprises us is that, despite these signs of a rapid slowdown in U.S. economic growth and the renewed escalation in trade tensions, the S&P 500 has held up surprisingly well,” says Paul Ashworth at Capital Economics. “If markets are pinning their hopes on a U.S.-China trade deal next month or on the Fed successfully saving the day, then they could be in for a rude awakening.”

Ashworth believes incoming economic data point to a “sharp” slowdown.

The bottom line

Many on Wall Street I have talked with these past few weeks continue to be optimistic on stocks this year. You can hear the optimism in their voices even as a good number of them are trimming winning positions into strength.

All of this dialogue suggests to me the market is one or two bad economic reports away from a sharp reversal as investment theses become derailed.

In this type of slowing environment, Corporate America is unlikely to announce bang up second quarters and is at risk at cutting their 2019 outlooks. I encourage all investors to listen to recent earnings calls from Target, Walmart, Deere, Macy’s and Best Buy to get a sense of the real profits the trade war is stealing.

That has to get priced into stocks, it’s that simple.

Nonetheless, let the Twitter tirades begin regarding this dose of business news analysis. Everyone thinks they’re right, until they are proven horrifically wrong. Sometimes it’s tough being a contrarian.

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

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