Going by the numbers, markets and the economy are doing great. The Dow, the Nasdaq, and the S&P 500 all broke several records last week – and all three closed at all-time highs on Friday afternoon.
But if you turn to the news, the picture is much less rosy. There’s no shortage of bad news for the economy. The big trade deal with China keeps getting postponed.
Just last month, the Fed had to step into the overnight “repo” lending market as banks faced a liquidity crunch. And this Thursday, Germany is expected to officially enter a recession.
Meanwhile, the unrest in Barcelona, Bolivia, Chile, Ecuador, Hong Kong, Lebanon, and beyond could have serious consequences for the global economy.
For now, these concerns are outweighed by the strength of the U.S. economy.
But there’s definitely a “wall of worry” on the horizon, one the markets will have to overcome to keep climbing.
Here’s what needs to happen for the markets to keep rising…
The Keystone of the Wall of Worry
You may have heard this “wall of worry” term and wondered what it really means. It originated in the 1950s. Investopedia explains the term like this: “Wall of worry is the financial markets’ periodic tendency to surmount a host of negative factors and keep ascending. Wall of worry is generally used in connection with the stock markets, referring to their resilience when running into a temporary stumbling block, rather than a permanent impediment to a market advance.”
Overcoming one of these market-squelching impediments (or even postponing dealing with them) gives the market a temporary shot in the arm. Bull markets are built when many of these obstacles are overcome in a series, over time. Thus the image of climbing.
Since President Trump’s election in November 2016, markets have been operating under the “Trump growth narrative.” This is the idea that Trump’s pro-business and market-friendly policies would give a boost to stock prices.
Except for a few hiccups, the markets have cooperated:
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But traders are growing increasingly concerned about that narrative.
The key worries won’t come as a surprise…
Trade and China.
We’ve talked a lot about the tit-for-tat tariff dispute with China recently, but the short of it is this: President Trump’s tariffs on Chinese materials and goods, and the threat to impose even more, has the potential to convince China to agree to a better trade deal.
In the meantime, the markets are stuck in uncertainty over what will happen, and when. Of course, uncertainty is what the markets dislike the most, so this is a crucial part of the wall of worry the markets face.
For months now, the markets have been riding high on China and the U.S. delaying a final trade deal, each time breathing a sigh of relief and climbing higher as increased tariffs are postponed or negotiations pushed back.
But that can’t go on forever.
And with negotiations having been in full swing recently, and both sides setting expectations for a first phase of a deal to be signed before the end of the year, kicking the can down the road might not work this time.
Instead, for the markets to keep rising, this issue may have to be dealt with in a tangible fashion. That means an actual trade deal signed – even it’s only a “phase one” deal.
What It Will Take to Keep Climbing
Bull markets don’t require everything to be peachy. Markets can rise even when news is mixed, as long as expectations are, on the whole, positive.
That’s why traders talk of “climbing a wall of worry” – concerns and problems are fine, as long as there is a way to climb over them and keep rising.
That’s what needs to happen on trade.
The issue has been delayed over and over, and with the U.S. election coming up, as well as both the U.S. and China signaling desire to come to terms on at least a partial deal before the end of the year, the market has accepted those signals and kept climbing – making half a dozen new all-time highs in the last couple of weeks.
To keep running higher, this bull market will need additional progress to happen on trade. But even if that worry is overcome, there are plenty more bricks in the wall of worry.
As we talked about previously, the unrest in Hong Kong could end up hurting China’s economy. Any Chinese military intervention in Hong Kong, for example, could easily scare away investors and businesses from the country and lead to sanctions.
That would be bad news for China’s economy, which is already at its weakest in more than a decade and facing a trade dispute with the U.S.
And so any positive news out of the Hong Kong protests – meaning toward resolution, not necessarily toward the meaningful democratic reforms the protestors are demanding – would give the market a solid bump up as it climbs the wall of worry.
The rest of the global economy is also struggling. Germany might officially enter a recession this Thursday. Any positive news out of the Eurozone in general, or Germany in particular, will push up prices and help to climb the wall a little further…
A messy Brexit especially could cause a hard but temporary upset in the British and European economy. So positive moves toward anything other than a worst-case Brexit climbs the wall of worry.
In the past month or so, the market has shown that positive news (or the expectation of future positive news) has outweighed the negative. And with the historical seasonally strong last two months of the year underway, the probabilities are the market will continue to pop higher with each piece of positive news, especially around trade negotiations.
An accommodative Fed and an optimistic short to mid-term economic outlook in the U.S. are underpinning the wall of worry climb. So until something changes in those key fundamental components, look for stocks to be bid up when worrisome issues are overcome (or kicked down the road further).
Great trading and God bless you,
D.R. Barton, Jr.