The U.S. Stock Market Is All Teed Up for a Nauseating Plunge

• The stock market’s rally is based on investor optimism and little else.
• Fatigue could set in soon as the same news keeps sending the stock market higher.
• A stock market crash could be coming if traders start to question the validity of the current rally.

With the Dow Jones Industrial Average climbing further above 29,000, investors are already speculating when the index will cross the 30,000 milestone. But the current stock market rally is walking a tightrope higher with the potential to come tumbling down at any moment— even the bulls say so.

Stock Market Could Crash If Fundamentals Don’t Catch Up

Economist Edward Yardeni was incredibly bullish when Barron’s asked him about his 2020 outlook last year, but even he says the current rally is a risky one . Earnings, the backbone of a strong equities market, aren’t living up to investors’ lofting expectations, Yardeni said.

On Tuesday, Yardeni’s research firm pointed out that the S&P 500’s forward P/E hit a cyclical high at 18.5. That’s because the index has gained a whopping 40% while earnings growth in 2019 was just 1.1%.

The stock market’s rally, he cautioned, is based largely on investor sentiment and lacks the fundamentals to back it up. 

[I’m] concerned that there is nothing to fear but nothing to fear. If the meltup continues, then the stock market’s valuation multiple will rise toward nose-bleed levels.

Earnings Could Disappoint

This week has seen some impressive earnings releases that have given investors confidence in the season ahead. But if strong guidance doesn’t materialize, it could create dangerous conditions leading to a stock market crash.

Deutsche Bank’s Global Chief Investment Officer Christian Nolting says investors should exercise caution because expectations have become far too high .

Earnings among global equities are seen rising by 20% in 2020. Nolting says that’s far too optimistic. He is expecting economic growth to slow in the coming year and says overdone earnings expectations could add to the market’s volatility.

That sentiment is also concerning because the market has continued to trade up on the same news over and over again.

As Jim Cramer put it ,

Maybe it’s time for a breather, because you just can’t keep going higher on the same news.

Trade Deal Uncertainty Haunts Markets

The U.S.-China trade deal is a prime example of the type of repeated news that has been driving this shaky rally.

The market hung on Donald Trump’s every word for the past few months as he hinted at the deal getting closer and closer. Now that phase one has been signed, investors are starting to question how beneficial it actually is. 

Experts say it’s unclear whether China will follow through  on its end of the bargain. Beijing promised to buy another $32 billion worth of U.S. agricultural products over the next 24 months. But the deal doesn’t include details on how China will execute on that promise. 

That means the market could suffer months of rhetoric about whether the trade deal is even working. At some point, fatigue will set in. That could kick off an epic stock market crash.

Impeachment Puts Downside Risks on Deck

The upcoming impeachment trial  also has the potential to cause a stomach-churning stock market sell-off.

When the Democrats voted to impeach Donald Trump, the market moved higher, contrary to what many expected. But if Trump is found guilty in the Senate, he’d be removed from office. That would be bad for markets any way you slice it.

It’s unlikely that Trump’s Republican peers would remove him from office, but that doesn’t mean it’s impossible.

That belief that the president is safe puts the market on extremely uneven footing— any news that suggests the contrary could cause a major pullback that has the potential to turn into a full-blown stock market plunge.

3,700 Is the Magic Number for the S&P 500

Not everyone is forecasting a stock market crash, though. JP Morgan analysts say their calculations show that the S&P 500 would have to hit 3,700  before they’d be concerned about the threat of a bubble.

They noted that in previous market bubbles, two or three years of growth followed by an aggressive 12-month rally ultimately led to an inflection point. For 2020’s market to fit that mold, the S&P 500 would need to gain another 12% by the second half of this year.

That scenario is unlikely when you consider that Oppenheimer’s John Stolzfus has the most bullish prediction for the index in 2020, and he sees it finishing well below the 3,700 benchmark at 3,500.

The Bottom Line

Whether you believe that a full-blown stock market crash is on the horizon or not, it’s worth keeping some powder dry in the event of a pullback, especially with earnings season unfolding over the next few weeks.

In today’s inflated equities climate, discounts are few and far between, so a sell-off could offer an opportunity to avoid the nose-bleed prices that the stock market is offering.