Market decline

“There is now an alternative to actions”

Warning strip outside the New York Stock Exchange in New York.

Adam Jeffery | CNBC

There’s a good chance stocks will stagnate next year as credit conditions tighten and earnings growth slows, according to Bank of America Merrill Lynch.

“We believe stocks are likely to peak before the end of 2019,” wrote Savita Subramanian, equity and quantitative strategist at Bank of America Merrill Lynch, in a note this week. She sees the increasing slightly to 3,000 by the end of this year, then decreasing by 3% in 2019 to 2,900.

“Our rates team calls for an inverted yield curve over the year, homebuilders peaked about a year ago and typically dominate stocks for about two years and our credit team is forecasting higher rates. spreads in 2019, ”Subramanian said. “Assuming the market peaks somewhere at 3,000 or above, our forecast is for a modest decline in 2019.”

An inverted yield curve refers to when the yield on short-term sovereign debt, like the two-year Treasury bill, is higher than the longer-term paper rate like the benchmark 10-year Treasury bill. An inverted yield curve is usually followed by an economic recession.

Investors have expressed concern this year about the possible inversion of the Treasury yield curve. The spread between 10-year and 2-year rates was around 24 basis points on Friday. This came as the Federal Reserve raised the overnight rate three times this year. The central bank is also expected to rise once more before the end of the year. The Fed is also forecasting that it will hike rates three times in 2019.

As the yield curve continues to flatten, Subramanian expects equity market volatility to increase and more “bear market signals” from the company to be triggered. Currently, 58 percent of these signals are triggered. In October 2007, about a year before the financial crisis, all 19 road signs were triggered.

“Still supportive fundamentals, still lukewarm fairness and more reasonable valuations keep us positive. But in 2019, we see a high probability of a peak in the S&P 500,” the strategist notes, adding that earnings growth The S&P 500 will likely slow to a crawl after a 2018 blockbuster. Profits on the S&P 500 rose 25% in the first three quarters of the year, driven in large part by lower corporate taxes.

Cash as an alternative

However, Subramanian says investors can now look to a place they haven’t been able to for a long time as stocks stagnate: cash. “There is now an alternative for stocks,” Subramanian said, noting that cash yields are higher today than for 60% of S&P 500 companies. “Cash is now competitive and will likely increase further… our call Fed puts short rates near 3.5% by the end of 2019, well above the S&P 500’s 1.9% dividend yield. “

Many investors have operated during this bull market under the mantra ‘There is no alternative’ to stocks after the financial crisis, as the Federal Reserve’s low rates made assets such as cash almost zero, thus making it unattractive to investors.

Subramanian has recommended investors buy stocks in health, tech and financials.

When it comes to healthcare, she says it is “cheap” from historical levels and is trading below the S&P 500 overall. She also notes that the fundamentals are strong for the sector. and that more than half of the companies exceeded profit and sales estimates in the third quarter.

Subramanian said the technology is now “cheaper” and less congested after a major industry reorganization moved Netflix and Facebook out of the industry. “The risk positioning is now neutral to positive,” she said.

Financials, meanwhile, should get a boost as companies in the sector accelerate their buyout programs. “While other sectors have been repurchasing stocks for almost a decade, financials were banned until recently. But financials share buybacks have increased significantly and the sector has the second highest dividend growth in the world. S&P 500. “

– CNBC Michael bloom contributed to this report.