An analysis of Wall Street’s 2018 trading performance shows stock indexes registering at an unprecedented low since the 2008 financial crisis.[1] According to the S&P 500 and Dow Jones Industrial Average, 2018 experienced a bull market, [2] and sustained a crippling 6.2 and 5.6 percent in losses, respectively.[3] In fact, 2018’s financial data further reveals that the NASDAQ Composite plunged 3.9 percent, eliminating a decade of gains.[4] But this begs the question: what was the cause of all this turmoil in the market? Generally speaking, a market’s corrosion is not attributable to any one cause, but is instead the result of many forces such as regulations,[5] negative externalities,[6] and incomplete information.[7] Recently, news publications of a reported breakdown in tariff negotiations[8] and peculiar statements made by the U.S. Treasury Secretary also had a debilitating effect on the market.[9] Indeed, investors were understandably apprehensive about trading while looking at this market carnage.[10]
Market Risks and Stocks
The new realities of the current market [11] create great risks for those investing in the stock market.[12] To mitigate against risky transactions, savvy investors can calculate the expected value (anticipated value) of their money when deciding on whether to invest.[13] While the expected value is important to investors, wise traders still need to take into account additional potential risks before trading.[14] Predicting how the market will react is a tricky endeavor. Nevertheless, it is important to ask whether 2018’s market issues will continue to persist, or whether the latest positive signs in investing point to a rejuvenating market. Only then can ambitious investors find clues to guide them in forecasting 2019’s stock market behavior.
The Threat of the Global Economy
Some risks – i.e. ‘systematic risks’ [15] – affect the global economy and cannot be diversified away thus, preventing investors from protecting themselves.[16] One such risk that lingered over from 2018 is the slowing of America’s economy.[17] Policy tug-of-wars about the economy’s direction can adversely influence market growth, stock prices, and inflation.[18] Provided that this is the case today, predicting stock market behavior would be meaningless if the strength of the economy were not first assessed.[19] Because of this, many investors take precautionary measures to study the economy and have looked to the Treasury yield to determine whether our country’s economy is healthy.[20] The Treasury yield has been characterized as a useful signal for notifying government officials and market participants of a looming U.S. recession.[21] The yield did just that when it “blinked red” earlier this month.[22] The yield curve inverted with the “10-year Treasury note falling below the yield on the 3-month T-bill.”[23] As a matter of fact, that recent inversion came on-the-heels of a previous warning in December of 2018, where the “spread between 3- and 5-year yields fell to negative 1.4 basis points.”[24] Taken together, both distress signals revived concerns that a new recession is possibly imminent. For investors, these indicators are particularly alarming because of its proven accuracy in predicting the past seven recessions,[25] consequently weakening investment optimism.[26]
The Federal Reserve
Throughout 2018, the Federal Reserve has increased interest rates four times.[27] The first rate increase ranged from 1.5 to 1.75 percent,[28] while the fourth increased rate was from 2.25 to 2.5.[29] By years end, two more rate hikes were suggested to take place in 2019 – causing another dip of stock prices.[30] For this reason, market observers were not happy because of the domino effect of rising interest rates.[31] Because of the added costs banks pay when loaning money from the Federal Reserve, banks seek ways of marking down their now increased transaction costs.[32] This means that the burden of raised prices is transferred to companies who are hurt when banks hike their lending fees and interest rates.[33] Rather than internalize these costs, certain business will cut back on purchases.[34] This leads to risk-adverse business ventures, which can stifle advances in technology and medicine.[35] Another consequence of increased rates is that the transaction costs are absorbed by consumers needing loans for important purchases such as car loans and mortgages.[36] Because the Federal Reserve’s decision to increase interest rates affects so many members of the marketplace, tracking rate hikes is another important tool for investors attempting to gauge the market’s reaction.[37]
Encouragement in the Market
Admittedly, the picture painted of the stock market in 2019 is a bleak one. However, because of new emerging considerations, optimism in the market has surged for three reasons. First, despite the losses incurred in 2018, the U.S. fared better in relationto other countries.[38] While the S&P 500 was down approximately 7%, France’s CAC 40 was off 13%, and Germany’s DAX 20%.[39] Though it may not be properly fitting to compare economic losses between different countries, measuring these differences still offers insight into how a country may deal with an unpredictable economy and minimize its losses.[40] Second, despite the four rate hikes in 2018, such increases can actually signal a healthy economy. After all, the Federal Reserve Bank typically adjusts interest rates in response to inflation.[41] As U.S. employment increases, [42], the ‘demand-pull’ for products will exceed supply in the market, which is good news for our economy.[43] Additionally, reports from the Federal Reserve committee suggests that only two rate hikes are scheduled for 2019.[44] However, investors should continue to be vigilant and keep in mind that future rate hikes are not fixed, but instead contingent on changing economic data.[45] Third, is the anticipation of IPOs in 2019.[46] IPOs are fresh stock that, when initially offered in the market, typically have strong demand and often encourages investors to trade in the hopes of strong sale earnings.[47] For instance, there have been reports of companies like Uber, Lyft, and even Airbnb going public, which has re-energized the market.[48] At the same time, investors must still be cautious. The ramifications of these IPOs are huge (Uber is valued at $120 billion valuation while Facebook is valued at $104 billion), and investors will both be jockeying for IPO stock, which will drive up prices.[49]
Conclusion
Notwithstanding some risks, investors have good reason to be optimistic for 2019. Though the U.S. economy lost some momentum, most analysts agree that it remains strong.[50] Additionally, if current inflation levels remain steady, the Federal Reserve will continue to wind-down their aggressive approach in market stabilization. [51] However, it is important to remember that these two big risks are both systematic as opposed to unsystematic risks (e.g.,change in management or new competition in the marketplace).[52] Therefore, as these risks continue to wane, a well-diversified portfolio can protect sophisticated investors.
[1] Fred Imbert, US Stocks Post Worst Year In A Decade As The S&P 500 Falls More Than 6% In 2018, CNBC (Dec. 31, 2018), https://www.cnbc.com/2018/12/31/stock-market-wall-street-stocks-eye-us-china-trade-talks.html.
[2] James Chen, Bull Market, Investopedia (Mar. 13, 2019), https://www.investopedia.com/terms/b/bullmarket.asp.
[3] Imbert, supra note 1.
[4] Id.
[5] Prateek Agarwal, Market Failures, Intelligent Economist (Dec. 24, 2017), https://www.intelligenteconomist.com/market-failures/.
[6] Id.
[7] Id.
[8] Richard Barbieri & David Goldman, A Head-Spinning, Jaw-Dropping 10 Days In The Markets, CNN (Dec. 29, 2018), https://www.cnn.com/2018/12/28/investing/stock-market-december-volatility/index.html.
[9] Id.
[10] Id.
[11] Chen, supra note 2.
[12] Scott Rothbort, 8 Most Common Types of Investment Risk, The Street (May 29, 2018), https://www.thestreet.com/story/10359668/1/types-of-investment-risk.html.
[13] See generally William T. Allen & Reinier Kraakman, Commentaries and Cases on the Law of Business Organization (5th ed. 2016); see also Imbert, supra note 1.
[14] Id.
[15] See generally Allen & Kraakman, supra note 13.
[16] Id.
[17] David Goldman, The 3 Biggest Risks To Stocks In 2019, CNN (Jan. 2, 2019), https://www.cnn.com/2019/01/01/investing/stock-market-dow-2019/index.html.
[18] Id.
[19] Ken Little, The Major Types of Risk for Stock Investors,The Balance (July 12, 2018), https://www.thebalance.com/major-types-of-risk-for-stock-investors-3141315.
[20] Understanding Treasury Yield, Investopedia (Nov. 26, 2018), https://www.investopedia.com/video/play/understanding-treasury-yield/; see also William Watts, The Yield Curve Inverted — Here Are 5 Things Investors Need To Know, MarketWatch (Mar. 25, 2019), https://www.marketwatch.com/story/the-yield-curve-inverted-here-are-5-things-investors-need-to-know-2019-03-22.
[21] Julia Horowitz, Dow Falls 460 Points As US Recession Indicator Flashes Red, CNN (Mar. 22, 2019), https://www.cnn.com/2019/03/22/investing/dow-stock-market-yield-curve/index.html.
[22] Id.
[23] William Watts, The Yield Curve Inverted — Here Are 5 Things Investors Need To Know, MarketWatch (Mar. 25, 2019), https://www.marketwatch.com/story/the-yield-curve-inverted-here-are-5-things-investors-need-to-know-2019-03-22.
[24] Katherine Greifeld, The Flattening Yield Curve Just Produced Its First Inversions, Bloomberg (Dec. 3, 2018), https://www.bloomberg.com/news/articles/2018-12-03/the-flattening-yield-curve-just-produced-its-first-inversion.
[25] Watts, supra note 23.
[26] U.S. Department of Treasury, Daily Treasury Yield Curve Rates (accessed Mar. 2, 2019), https://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yield.
[27] Fed’s Bostic Sees One US Interest Rate Increase This Year, CNBC (Jan. 7, 2019), https://www.cnbc.com/2019/01/07/feds-bostic-sees-one-interest-rate-increase-for-2019.html.
[28] Lucy Bayly, New Fed Head Approves First Rate Hike Of 2018, MarketWatch (Mar. 21, 2018), https://www.nbcnews.com/business/economy/new-fed-head-approves-first-rate-hike-2018-n858726\.
[29] Jeff Cox, Fed Hikes Rate, Lowers 2019 Projection To 2 Increases, CNBC (Dec. 19, 2018), https://www.cnbc.com/2018/12/19/fed-hikes-rates-by-a-quarter-point-.html.
[30] Juan Carlos Arancibia, Stock Market Forecast For 2019: 7 Critical Trends To Watch, Investors (Dec. 29, 2018), https://www.investors.com/news/stock-market-forecast-for-2019/.
[31] Marry Hall, How Do Interest Rates Affect the Stock Market?, Investopedia (Jan. 16, 2019), https://www.investopedia.com/investing/how-interest-rates-affect-stock-market/.
[32] Id.
[33] Id.
[34] Id.
[35] See generally Allen & Kraakman, supra note 13.
[36] See Hall, supra note 31.
[37] Id.
[38] See Arancibia, supra note 30.
[39] Id.
[40] Id.
[41] Akin Oyedele, Here’s How The Fed Raises Interest Rates And Why It Matters, Business Insider (Dec. 19, 2018), https://www.businessinsider.com/how-the-fed-raises-interest-rates-2017-12.
[42] Jeffry Bartash, U.S. Gains 304,000 Jobs At Start Of 2019 As Firms Continue To Hire At Blistering Pace, MarketWatch (Feb. 1, 2019), https://www.marketwatch.com/story/us-gains-304000-jobs-at-start-of-2019-as-firms-continue-to-hire-at-blistering-pace-2019-02-01.
[43] Jacquelyn White, What Is Demand-Pull Inflation and What Causes It?, The Street (Feb. 28, 2019), https://www.thestreet.com/investing/what-is-demand-pull-inflation-14879218.
[44] Donnba Borak, Fed Indicates It Will Slow Down Rate Hikes In 2019, CNN (Jan. 9, 2019), https://www.cnn.com/2019/01/09/economy/federal-reserve-december-minutes/index.html.
[45] Id.
[46] IBD Staff, IPO Stock News And Analysis: Find Today’s Top New Issues, Investors (Mar. 28, 2019), https://www.investors.com/research/ipo-stock-news-and-analysis-find-todays-top-new-issues/.
[47] Id.
[48] John Divine, 9 Major Upcoming IPOs To Watch In 2019, U.S. News (Jan. 8, 2019), https://money.usnews.com/investing/stock-market-news/slideshows/best-stocks-ipo-this-year?slide=11.
[49] Id.
[50] Greg Robb, Fed Jettisons 2019 Rate-Hike Plans As Economy Slows And Inflation Softens, MarketWatch (Mar. 20, 2019), https://www.marketwatch.com/story/fed-seeing-slower-growth-and-softer-inflation-now-projects-no-rate-hikes-this-year-2019-03-20.
[51] Id.
[52] See generally Allen & Kraakman, supra note 13.
