- The outlook for stocks has grown bullish but forecasters still see a handful of big risks.
- Recession, debt bubbles, and overvalued stock markets are headwinds.
- There are also a handful of low probability outlier events on Wall Street’s radar.
Investors are feeling bullish after the Federal Reserve flashed a major dovish signal to markets this week — but stocks still face a cocktail of risks headed into the new year, Wall Street forecasters say.
Bearish predictions have become the counter-narrative of late as investors and analysts dial up their expectations for stocks to hit all-time-highs next year.
Those predictions are grounded in the outlook for the Fed to start cutting interest rates as early as the first quarter. In the central bank’s summary of economy projections at its meeting on Wednesday, officials hinted at 75 basis-points of rate cuts next year, a move that vaulted the Dow to a fresh all-time-high this week.
But the bullish mood shouldn’t gloss over risks that are still facing the market, and experts say there are still big headwinds to another major rally next year,
Here are some of what Wall Street sees as big risks to stocks in 2024.
1. Recession strikes
Though the Fed is expected to dial back interest rates soon, the economy still risks tipping into a recession, thanks to the accumulated financial tightening that’s already taken place in the economy.
Even a “hint of a recession” could send stocks plunging, French bank Société Générale warned, and there are parallels between today’s market and conditions seen in 1987. That was the year the market was roiled on Black Monday, when the Dow plunging 22% in a single trading session.
“The equity market’s current resilience in the face of rising bond yields reminds me very much of events in 1987, when equity investors’ bullishness was eventually squashed,” strategists at the financial services firm said in recent note. They added that stocks could see a “devastating blow” if a recession were to strike.
That bearish view is shared by strategists from BCA Research, who warned stocks could plummet as much as 27% when the economy tips into a recession. A plunge that steep would mark the worst stock market crash since the 2008 financial crisis.
“A recession in the US and euro area was delayed this year but not avoided. Developed markets (DM) remain on a recessionary path unless monetary policy eases very significantly. As such, the risk/reward balance is quite unfavorable for stocks,” BCA said.
2. The debt bubble bursts
Universa Investments, a hedge fund that counts “The Black Swan” author Nassim Taleb as an advisor, recently predicted stocks would experience a crash even steeper than 1929. That’s due to a huge debt bubble forming in markets when interest rates were ultra-low, which is set to pop as borrowing costs remain higher-for-longer.
“We are in the greatest credit bubble of human history,” Universa’s chief investment officer Mark Spitznagel said in an interview with the Intelligencer. “It’s entirely because of artificially low interest rates, artificial liquidity in the economy that has really happened in a big way since the great financial crisis.”
Markets saw a wave of corporate debt defaults so far this year as rate rose and refinancing became more expensive for companies. A worsening pace of debt failures could spell trouble for stocks, and a tougher credit environment combined with a full-blown recession could result in nearly $1 trillion of corporate debt defaults, Bank of America previously estimated.
3. The highly valued S&P 500 sees a big correction
Parts of the S&P 500 are looking overvalued. Ultra-low rates throughout the pandemic drove a stock-market frenzy that has culminated this year with a wild run-up in a select handful of stocks. Dubbed the “Magnificent Seven,” these tech firms have seen massive investment this year, eclipsing the gains in the rest of the benchmark index.
As the era of extreme liquidity comes to an end, rates are likely to stay higher for longer, even with the outlook for rate cuts next year. That could be bad news for some of the market’s most hyped stocks.
Legendary investor Jeremy Grantham told Business Insider he expected the S&P 500 to plunge as much as 52% in the worst-case scenario, thanks to a “superbubble” that’s bound to burst. A drop that steep could send the S&P 500 plunging to 2,200, an even steeper drop than when stocks initially crashed in the early days of the pandemic.
Stocks are looking so overpriced that the market could crash as much as 60%, veteran investor John Hussman recently warned. He compared the current stock environment to years like 1929 and 2000, right before the Great Depression and the bursting of the dot-com bubble.
“That’s not a forecast, but it certainly is a historically consistent estimate of the potential downside risk created by more than a decade of Fed-induced yield-seeking speculation,” he said in a research note. “Buckle up.”
Fears of a stock market crash have been rising steadily even as the bullish chorus grows in the latter part of this year. According to Yale’s US Crash Confidence Index, 61% of institutional investors think the odds of a 1987-style stock market crash is higher than 10%.
4. A Black Swan event
While Black Swan events are by their nature unforeseen and therefore difficult to predict, there are a few outlier scenarios that investors are eyeing that could spoil the party in markets.
Risks of a Black Swan event on par with something like the COVID-19 pandemic stem mostly from the high level of geopolitical risk in the world as 2023 winds down.
Top economist and market doomsayer Nouriel Roubini in a recent op-ed pointed to escalating tensions between the US and China as one such event that could trigger a calamity. Aggression between the superpowers could eventually heat up into a full-blown war, which could be catastrophic for the world economy, Roubini warned.
“If they fail to achieve a new understanding on issues driving their current confrontation, they will eventually collide … That would lead inexorably to a military confrontation that would destroy the world economy, and which could even escalate to an unconventional (nuclear) conflict,” according to the “Dr. Doom” economist, who is known for his bombastic prognostications on Wall Street.
Conflict between Israel and Hamas, meanwhile, could also spill out into the wider Middle East region, Roubini said in a recent Bloomberg interview. Spreading conflict could cause oil prices to spike, potentially sparking a stagflationary crisis in the west.
Roubini recently warned that a stagflationary crisis could cause investors to lose trillions of dollars over the next decade.
“It’s not the baseline scenario, but it’s a risk,” Roubini said shortly after the latest conflict between Israel and Hamas began in October. “Markets seems to be discounting the possibility of a massive conflict for now,” he added.
