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Investors may be overly complacent about 2020

There is an eerie sense of calm on Wall Street heading to the end of the year. It's the inverse of last year's December market panic.Stocks are at all...

Posted: Dec 21, 2019 6:52 AM

There is an eerie sense of calm on Wall Street heading to the end of the year. It's the inverse of last year's December market panic.

Stocks are at all-time highs. The CNN Business Fear & Greed Index is hovering above 90 -- firmly in Extreme Greed territory -- for the first time since 2017. The index, which tracks the VIX volatility gauge and six other measures of investor sentiment, can't go higher than 100.

But are there risks investors are ignoring?

The trade war isn't necessarily over. Earnings estimates and valuations may be too high.

And oil prices have crept up lately while the dollar has softened, raising the potential specter of commodity inflation. Could the Federal Reserve have to (gulp) raise rates in 2020 after all?

"I'm worried about complacency in the near-term. Some froth has been building here," said Liz Ann Sonders, chief investment strategist with Charles Schwab. "Inflation could be one of those things that picks up, especially since so many people think inflation is dead and buried."

Of course, rate hikes in an election year are unlikely. (President Trump's bashing of Fed chief Jerome Powell on Twitter would probably escalate to alarmingly new levels.) But they're not completely out of the question.

The Fed, after all, reacts to data and tries to be as apolitical as possible. If inflation pressures mount, the Fed may be forced to act -- just as it did in 1992 in the midst of a presidential race. After he lost to Bill Clinton, President George H.W. Bush famously blamed former Fed chair Alan Greenspan for keeping rates too high.

Inflation returns with a vengeance?

That's why some strategists see inflation creeping up as a possible 2020 problem for the markets and economy.

"Crude prices have held above the $60 level. If oil continues to go higher over the next six months are we going to be talking about inflation?" said TD Ameritrade chief market strategist JJ Kinahan.

"We haven't talked about inflation for so long -- and it's the punch you don't see that usually knocks you out," Kinahan added.

Kinahan notes that in addition to higher commodity prices, wages are steadily increasing and the dollar has weakened following a strong start to the year. Add all that up and inflation pressures may start to eat into corporate profits.

That could be bad news for stocks, given that valuations are starting to look a bit rich.

"If the Fed reacts to inflation and starts raising rates, then I would get nervous," said John Schlifske, chairman, president and CEO of Northwestern Mutual. "There's always the potential for a curve ball. Central banks around the world in general are a risk."

Earnings estimates may need to come down

Inflation isn't the only possible bugaboo that could derail the stock market and the economy.

Sonders said she's keeping a close eye on potential cracks in the job market. Sure, employers are still adding a healthy number of workers and the unemployment remains near a half-century low.

But she noted that there have been "troubling kinks" in the most recent weekly jobless claims numbers, with more people filing for unemployment benefits in states with big agricultural and industrial industries -- i.e. those with more exposure to tariffs and the trade war with China.

Profit forecasts for 2020 might be too high, Sonders said, and she's concerned that businesses will need to absorb the hit from higher tariffs instead of passing them on to consumers.

"Manufacturers have been talking about how sourcing in China is an issue and companies are limited with what they can do to shift their supply chains. They are doing the best they can but they are eating a lot of the higher costs," Sonders said.

Don't ignore the 2020 election and Brexit

Political uncertainty remains as well, at home and abroad.

"The market could have a stronger reaction to political rhetoric once we get past the conventions and have a clear Democratic candidate," said John Conlon, chief equity strategist with People's United Advisors.

While investors often try to ignore the noise, there is a chance that two sectors that have performed well this year -- technology and health care -- could get hit, Conlon said. President Trump has talked about reining in drug prices and he has made no secret of his animosity towards Amazon, Facebook, Google owner Alphabet and other tech giants.

And the more progressive Democratic contenders, most notably Elizabeth Warren and Bernie Sanders, also have bold plans for the health care and tech industries.

On the international front, American investors may need to pay more attention to the chaotic Brexit situation and the potential that market turmoil could spill over to the European continent. If that happens, the economies of big European nations like Germany could slow. That, in turn, could further weaken growth in China given how much that nation relies on Europe as an end market.

Rich Sega, global chief investment strategist for Conning, worries that Europe could be a drag on global growth. "That's not going to get better with Brexit and how that will impact exports to China," he told CNN Business.

In other words, the market still has a lot to worry about -- but you wouldn't know it by looking at how well the Dow, S&P 500 and Nasdaq have done this year.

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