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Some of These 10 Macro Risks Could Burst the Stock Market Bubble in 2020

Last Updated September 23, 2020 1:25 PM
Sam Bourgi
Last Updated September 23, 2020 1:25 PM
  • U.S. stocks extended their record-setting rally on Friday.
  • The S&P 500 Index is on track for yearly gains in excess of 28%, one of the best since 1997.
  • Morgan Stanley warns that the bull parade could be disrupted by ten macro risks set to dominate the headlines next year.

The Dow and broader U.S. stock market touched all-time highs on Friday, extending a stellar run of gains for the major indexes heading into 2020.

Volatility is low and optimism is high, a seemingly perfect combination for risk-on investors as they continue to bet on the return of stable U.S.-China trade relations. But an over-reliance on central-bank liquidity, as evidenced by the Federal Reserve’s shocking intervention in the financial markets, has created a hefty dose of skepticism on the fringes of Wall Street.

Now, that skepticism is permeating the mainstream after Morgan Stanley identified ten macro risks keeping its strategists up at night. These risks are expected to become more acute as we head towards the U.S. presidential election.

Macro Risks Loom Large

Morgan Stanley Wealth Management has unveiled a list of ten macro risks for markets  in 2020 that are keeping its analysts up at night. The list, ranked from most to least likely, paints a troubling picture for risk-takers heading into next year.

Here’s the list (paraphrased by the author):

  • 1. Leadership race in the democratic world
  • 2. The emergence of competing trade blocs
  • 3. China: Politics and economy
  • 4. U.S. election volatility
  • 5. European stimulus that is too little, too late
  • 6. Inequality and the growth of populism
  • 7. Preparing fro “Japanification”
  • 8. Cyber war
  • 9. Iran
  • 10. The dark side of gene editing

Most of these risks are familiar to investors who have put up with endless headlines about the U.S.-China trade war, protectionism and the 2020 presidential election. Others, like gene-editing, have flown under the radar.

President Trump’s failure to win re-election in November – a remote possibility at this stage – could be the pin that pops the equity bubble. His election in 2016 triggered what’s now known as the Trump reflation trade – a period of extreme optimism that saw traders bid up stocks in hopes of faster economic growth, tax cuts and deregulation. His ousting, in favor of a far-left candidate no less, could have the opposite effect.

Investors who don’t believe stocks are in a bubble should look more closely at the economic data, languishing corporate profitability and collapsing bond yields. At the very least, they should weigh President Trump’s ability to influence high-frequency trading algorithms through his communications about China trade talks. Markets are relying far less on fundamentals and more on ‘hopium’ in the bid for even higher prices.

2019: A Massive Year for Stocks

2019 was a year of uncertainty and turmoil for global markets. The onset of the U.S.-China trade war was only the tip of the iceberg. A political crisis in Hong Kong, inflation scares across several major markets and the synchronized slowdown in global growth all weighed on investor sentiment.

Central banks managed to stem the downside risk, albeit temporarily, with their usual bag of tricks. The calendar year produced 66 interest rate cuts by central monetary authorities, including three by the Federal Reserve.

Morgan Stanley strategists sent a strong signal that the European Central Bank (ECB) is unlikely to succeed in its stimulus drive. ECB stimulus reached truly epic proportions earlier this year after Germany, the Eurozone’s largest economy, contracted. The moves are seen as too little, too late for a region that has failed to fully shake off the aftermath of multiple crises since 2008.

In spite of all that, major markets have produced double-digit percentage gains this year. Here’s a rundown of the 12-month returns for the major indexes:

  • Nikkei 225 (Japan): 16.8%
  • CSI 300 (Mainland China): 31%
  • MSCI AC Asia Pacific (Asia): 16.5%
  • Euro Stoxx 50 Pr (Eurozone): 25.9%
  • FTSE 100 (United Kingdom): 13%
  • DAX 100 (Germany): 25.5%
  • S&P 500 Index (United States): 30.6%

S&P 500 Approaches Major Milestone

For all of 2019, the benchmark S&P 500 Index is up more than 28.5% after Friday’s close. That’s fairly comparable to the high-flying Nasdaq, which has returned 34.5% since Jan. 1.

S&P 500 Index
The benchmark S&P 500 Index closed up 0.5% at 3,221.23 on Friday. All 11 primary sectors reported gains. For the year, the index is up more than 28%. | Chart: barchart.com 

As MarketWatch pointed out , the large-cap index is now less than 2% away from surpassing 2013’s return. That would put the S&P 500 on track for its best year since the dot-com craze of 1997.

If history is any indication, stocks are poised to end 2019 on a high. That’s because the so-called Santa Claus Rally elevates equity prices after Christmas and into the New Year.

At least some of the dangers flagged by Morgan Stanley could rear their ugly head in the early part of next year. Combined with overvaluation risks , stocks will struggle to repeat this year’s performance in 2020.