While economic and earnings growth may slow this year, they are unlikely to turn negative, despite what recent market volatility suggests.
Last month, the S&P 500 fell 9%, making it one of the worst Decembers for stocks since the Great Depression. Declines were driven by slowing global growth, indications the Federal Reserve would keep raising interest rates and uncertainty about Washington policies, all of which created anxiety among investors that recession could be around the corner.
I see low probability of that scenario. And, since markets have essentially priced in a recession, I think there is likely upside for stocks from here, once the current bout of volatility subsides.
Below are three reasons why a recession does not seem to be in the cards:
- U.S. growth remains positive. While earnings and economic growth are likely to slow, they shouldn’t turn negative. Gross Domestic Product could decelerate to roughly a 2% pace from last year’s 3%-plus rate. Earnings growth above 5% seems achievable. That’s down markedly from the 25% pace of last year, but still increasing.
- The Federal Reserve is likely to pause on rate hikes if the economy weakens more. Late last year, investors feared the Fed would be too aggressive about raising rates into a slowing economy (Fed rate hikes typically act as a break on economic growth). But more recently, Fed officials have promised to be patient about returning rates to pre-financial crisis levels. Meantime, financial conditions and market liquidity are not deteriorating.
- China and emerging market economies are likely to rebound. China’s slowdown last year, partly a result of trade disputes with the U.S., was a major drag on global growth. I expect improvement in China this year, a healthier backdrop for global business. The likelihood that a trade deal with China could be reached by March 1 has improved in recent weeks.
Analysts still will likely need to ratchet back their earnings forecasts for many companies to account for slower U.S. growth, but that negative could be offset by a rebound globally.
Given current low stock valuations, I’m increasingly convinced that markets could rise this year as improved global growth provides a cushion against weaker conditions in the U.S.
Once volatility subsides, I suggest investors look for opportunities in stocks with attractive valuations, strong cash flows and growing dividends.