By Michael Wursthorn and Akane Otani | WSJ.COM
Stocks around the world are rallying at the fastest pace in months, the latest sign that the fears investors grappled with late last year have largely subsided. But worries remain that markets still aren’t on solid ground.
The Dow Jones Industrial Average has risen for five straight weeks, its longest winning streak since August. It isn’t alone: Stock indexes from Europe to Brazil to Shanghai are on track to close out January with their biggest monthly gains in at least a year, a sharp rebound after financial markets took a drubbing at the end of 2018.
Some analysts have credited the rally to bets that the Federal Reserve will slow its pace of interest-rate increases and hopes that the U.S. and China will make progress on trade negotiations. All told, global stocks have reclaimed more than $3 trillion in value after shedding $6.8 trillion last year, according to S&P Dow Jones Indices.
Yet beneath the rally, signs of caution have emerged. Those signs are unsettling investors who believe the gains belie a market that remains on fragile footing. The last time many global stock indexes rose this quickly was in January 2018—when markets around the world rallied, only to tumble in February as a number of volatility-tied bets collapsed.
Adding to the skepticism, many investors believe the recent rebound has been spurred in large part by buyers returning to the market for discounted shares after December’s fire sale—not by conviction that the global economy will find fresh momentum this year. Data last week showed that China’s economy, the world’s second largest, grew at the slowest pace in nearly three decades in 2018. Manufacturing activity has cooled across the eurozone, while the once-hot U.S. housing market has faltered as high prices squeeze buyers.
Investors will get a fresh look at the health of U.S. companies this week when a number of technology giants, including Apple Inc., Facebook Inc. and Amazon.com Inc., report quarterly results. Lukewarm forecasts from the trio in the fall raised fears of a broader downshift in growth. The S&P 500 is up 6.3% for the year, although it remains off 9.1% from its September record.
“The market will probably take another leg down by the second quarter,” said Randy Swan, founder of Swan Global Investments, a $4 billion money manager. “We’ve had this natural reaction after a large selloff, but the economy is slowing down and earnings are weakening.”
There are no signs yet that the U.S. is on the precipice of a recession. The domestic labor market remains robust, with a gauge of layoffs falling to its lowest level since 1969. On average, jobless claims have to be rising for more than a year before signaling that a recession is on the horizon, said Steven Chiavarone, a portfolio manager at Federated Investors.
Meantime, wages last month posted their biggest full-year gain in a decade. That sign of a healthy economy suggests to some investors that the bull market has more room to run. And the move Friday to reopen the federal government for three weeks at least temporarily shelved an issue that worried investors about the impact on the economy.
But analysts noted that stocks have historically taken years, not weeks, to fully reverse declines of the scale that they suffered last year.
The S&P 500 came to the brink of falling 20% from its record—the definition of a bear-market—in December. When the broad index has fallen more than 20% in the past it has taken an average of 63 months for it to hit a new high, according to Wells Fargo Investment Institute, an investment advisory owned by the bank.
For the market to defy history, investors would have to feel confident that a number of remaining worries, ranging from trade to slowing global growth to decelerating earnings, are on the retreat, according to the advisory group. It added it believes investors should maintain, rather than add to, their equity allocations in their portfolios.
So far, few investors believe these challenges are going away. In fact, some analysts and investors said the stock market’s about-face is surprising, given that many of the problems that contributed to the year-end rout continue to hang over the market.
The Fed has left its rate path open to changes if the economy shifts unexpectedly. The U.S. and China have yet to reach a resolution in their trade fight. And earnings are expected to grow more slowly this year than last, although so far in the fourth-quarter reporting season companies have largely been beating analysts’ estimates.
Stock volatility has cooled a bit since December, when thinly staffed trading desks and downbeat economic news combined to produce large swings. Many analysts believe the moves were exacerbated by computer-driven trading, which they said likely automatically issued sell orders as stock declines deepened.
Despite the January reprieve, many analysts believe markets could face further waves of volatility in coming months. Morgan Stanley analysts say the S&P 500 could still test its December lows, adding that they don’t think market valuations and sentiment have dropped far enough to justify a sustained rebound.
Countries around the world also face an unprecedented level of policy uncertainty. The Economic Policy Uncertainty Index, a gross domestic product-weighted average of uncertainty levels in 20 countries, hit its highest level ever last month. Factors such as the U.S. government shutdown and the U.K.’s wrangling over a Brexit deal could deter investors from re-entering the market, Goldman Sachs analysts said.
Even those who remain relatively optimistic expect a bumpy road ahead for markets. “It’ll likely be a volatile year with unquantifiable concerns,” said Ron Temple, head of U.S. equities and co-head of multiasset investing at Lazard Asset Management. He said clients should take a second look at their holdings.
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The risk of the U.S. slipping into recession in 2019 still looks quite low, he said. But “this is when you want high-quality companies, great returns on capital and strong balance sheets—in case I’m wrong.”