Recent positives have been priced in, which may leave little upside the rest of the year without a boost in growth and earnings.

Stocks got off to a strong start in January and February with the S&P 500 gaining a historic 12%. The market, however, has slumped since the start of March. While investors may still see plenty of positives to stay in stocks, I believe the downside risks are increasing. 

My recommendation is for investors to orient their equity portfolios toward high-quality stocks that aren’t overpriced. I also suggest favoring actively managed funds, which may be better able to navigate the potential rise in volatility than passive index funds.

Below are three reasons why the stock market may be riskier right now than it seems:

  • Economic data is mixed. Employment is still strong and the service sector is healthy. Yet the consensus of analyst expectations for first-quarter gross domestic product growth is now below 1%. That’s down from 3.4% GDP growth in the third quarter of 2018 and the government’s current estimate of 2.6% for last year’s fourth quarter. Recent economic reports show corporate capital spending is falling. Weaker home and auto sales are further evidence we are in the later stages of the current economic cycle, something I’ve been saying for a while now.
  • China’s economic recovery may not provide the boost expected. Although the U.S. and China are nearing a trade deal and China is actively stimulating its economy (one reason U.S. markets rallied at the start of the year), I’m not confident that an economic rebound in China will translate to growth in the U.S. I think it may lead to a consumer recovery in China that has minimal impact on the U.S. economy and markets.
  • Stocks are not cheap while corporate profit growth is slowing. Earnings growth peaked in the third quarter of last year and the consensus of stock analysts’ estimates for 2019 S&P 500 earnings growth has fallen to 3% from 10% last summer. Morgan Stanley Chief Equity Strategist Mike Wilson expects only 1% gain in year-over-year earnings. Yet, based on a forward price-earnings ratio above 16, stocks are now valued at the same level as last year’s third quarter. That suggests that stocks are fully priced and could weaken on negative news.

It’s normal for stocks to take a breather after such a strong start to the year. However, I believe the market backdrop is more perilous than it seems. For stocks to climb from here, we will likely need to see stronger economic growth and better corporate earnings, and I’m not confident that either will materialize.

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