Yahoo Finance 3 Risks for the Stock Market Ahead
Trick or treat. What will the stock market deliver during the notoriously volatile month of October?
The U.S. stock market bull cycle is old -- in its seventh year. By traditional measures, it is overvalued, yet the Standard & Poor's 500 index remains within spitting distance of its all-time high. That could be a recipe for volatile trading ahead.
"I think it's fair to say that U.S. stocks are the most expensive stocks around the globe today," says Tim Courtney, CIO of Exencial Wealth Advisors in Oklahoma City. "There are certain pockets of U.S. stocks that are extremely expensive. Areas such as utilities, consumer staples and REITs are trading at prices at which they have rarely, if ever, traded."
High valuations in and of themselves don't necessarily turn bull markets into bears. Stocks are a bit overvalued, says John Canally, vice president and economist at LPL Financial, headquartered in Boston. "But there is little correlation between valuation and stock returns in the short run," he says. "In the long run, the slightly above-average valuations today suggest that we may see slightly below average stock returns over the next 10 years or so."
[See: 20 Awesome Dividend Stocks for Guaranteed Income.]
Nonetheless, a number of analysts are warning that the stock market is vulnerable to a bout of volatility over the next month with a number of potential triggers that could lead to a corrective pullback and tug stock prices down from the nose bleed section.
Here are three market risks analysts are monitoring closely:
The U.S. presidential election. The U.S. stock market could be quite volatile over the next three months, says Colin Cieszynski, chief market strategist at CMC Markets in Toronto.
"As was the case with the Brexit vote back in June, I don't think the markets have priced in any outcome other than a Clinton victory ... the prospects that Trump could pull out a surprise win could rattle the markets in the coming weeks, particularly as Election Day draws near," Cieszynski says.
Others agree the outcome of the Nov. 8 presidental vote could rock the stock market.
"Risks exist in terms of the market underpricing a potential President Trump," says Mark Luschini, chief investment strategist at Janney Montgomery Scott in Philadelphia. "If it seems as though he's going to be elected president or polls show that he's gaining on Clinton, the market would respond negatively as this is a factor currently underpriced in the market."
Federal Reserve hikes interest rate. The Federal Reserve also could throw a wrench into the typical Santa Claus rally that tends to emerge on Wall Street in December with an interest rate hike at its Dec. 13-14 meeting.
"With the Fed likely to raise interest rates in December, the upside for U.S. stocks could be capped with the easy money which has been driving indices higher in recent years starting to recede," Cieszynski says.
Third-quarter earnings and guidance. U.S. consumers still appear to be spending, Cieszynski says.
"It remains to be seen if election uncertainty has had any impact on business investment plans," he says. "It may be dragging on hiring (but) it's hard to say. If earnings fail to meet high expectations or if guidance is murky due to the election or other factors, stocks could retreat."
"Those are the three triggers that, if the market is surprised by these outcomes, could cause a correction. All three will certainly increase volatility. Even if we don't have a full-blown correction, we will likely see more days of 1 to 2 percent moves," Courtney says.
[See: 7 Global Goats That Could Bring Market Mayhem.]
There are even more risks lurking in the stock market's shadows, such as missteps by China as it deals with its bad-debt problem or by the U.K. government as it negotiates its exit from the European Union, as well as a major terror attack, Canally says.
"These risks could cause a pullback, and perhaps even a pullback as large as 20 percent, but absent a recession, any pullback would likely be limited to a 15 to 20 percent drop, and met with buyers, not more selling," he says.
Other analysts agree the end of the bull market is not in sight.
"For the U.S. to end the bull market and to have a 20 percent pullback, we would most likely have to go into recession," Courtney says. "We don't see that happening. We think that it is more likely we continue to move along in this slower growth environment, where it seems like no one is happy but the recession is avoided. That should allow the bull market to continue."
Courtney says stocks are ripe for a pullback, with a 5 to 10 percent decline possible over the next couple of quarters.
"That is normal," he says. "If you have some cash on the sides, be prepared to be able to take advantage of that. Use those price pullbacks to your advantage."
Investors could build a potential buy or wish list to put their cash to work if stock prices retreat. Luschini points to housing-related stocks, technology and energy as areas to consider.
Also,"telecom is currently reasonable and we are increasingly encouraged by bank performance as marginally higher interest rates could increase net interest margins," he says. "We also like biotech, but these could be jeopardized by who occupies the White House come January."
Courtney likes the lower-priced areas, such as U.S. small-caps, value companies and international companies.
"These areas are riskier, but we believe that much of this risk is already accounted for in their lower priced stocks. History has shown that lower priced assets generally outperform higher priced assets moving forward," he says.
[See: 10 Ways to Play the Explosive World of Small-Cap Stocks.]
"If you're going to buy individual stocks, we believe you should buy companies that are leaders in their industry, have disciplined management teams and have good rates of growth in sales or earnings," Courtney says.
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