Stock Market: Prepare For An Opportunistic Drop

This stock market certainly looks good, with positive developments supporting confidence. Four popular items are:

1. The Federal Reserve’s new “patience” policy
2. Economists’ no-nearby-recession assurances
3. A potentially favorable U.S.-China trade-and-tariff agreement
4. Stocks’ desirable returns, steadily earned

So, why should the market decline?

Those four popular drivers, above, are, well, too popular. There is little surprise left, and the good news is built in. Even the expectations about the unresolved trade-and-tariff issues lean to positive outcomes.

On the negative side, there are many uncertainties and risks not widely discussed. Even last quarter’s bear market now seems irrelevant, given this year’s notable market gains.

(Fortunately, Barron’s reminds us that the two market periods are linked. This week’s article, “Stocks Off to Best Start in 28 Years,” [print edition] includes the subhead, “Market jumps 11% in January and February, following its worst December since 1931.”)

Incorrect view of today’s stock market (too limited)…

Correct view of today’s stock market (includes tariff reactions, all-time highs and bear market from which this year’s stock market emerged)…

Think of today’s situation as one of those periods when the market’s rise implies that fundamentals are good and risks are small. The problem is the negative possibilities are alive and well.

It is this market-driven confidence that can produce an opportunistic decline. All the market needs is a gentle push – down – to produce the search for the reasons why, thereby bringing to the forefront those many possible negatives.

How big a drop should we anticipate?

In a normal market, we could expect to see a 5% market dip (accompanied by variously timed, individual stock dips of 5% to 10%). However, this market is not normal. Investors will likely be quick to recall the bear market’s distress and the slowing economy concerns that led to discussions of recession. Without the support of a rising market, the mood could turn worrisome, meaning a larger decline is likely.

Additionally, the market’s steady rise (like what we saw preceding the bear market selloff) produced a pattern without clear, downside support levels. Add to that technical void the fact that many stocks have not yet cleared upside technical barriers, and a small decline could become a downside omen.

Therefore, a more likely drop would be a 10% market correction (individual stocks, 10% to 20%).

The wild card: What if the drop is based on fundamentals?

The one, major, overriding, critical assumption made above is that the economy’s growth rate will not slow further, and that today’s risks will not become reality.

We currently are getting the slower growth economic reports foreseen by the stock market last quarter. The problem is a market drop at this time would trigger the concern, “Is the stock market beginning to anticipate more slowdown ahead?”

The bottom line

Articles have suggested that the stock market now needs a catalyst to continue rising. But what if the market, without a catalyst, dips? As the search for “why the dip?” reasons brings forth negative uncertainties and risks, that dip could end up serving as the catalyst for a larger stock market decline.

A 10% correction seems likely, providing an attractive buying opportunity.

However, a deeper decline is possible (likely) if more growth slowdown is seen and/or some of the uncertainties/risks are viewed as more probable.

Hopefully, as the decline unfolds, there will be signs, perhaps contrarian indicators, to guide us.