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Why a 20% Market Meltdown Is Coming

Stock investors should brace for more market meltdowns ahead that are similar to the 20% top to bottom plunge in the S&P 500 index (SPX) from September to December that shook investors, according to several veteran market watchers. "Over time, you will probably see several more market events like we saw in December," Daniel Pinto, co-president of JPMorgan Chase and head of its investment banking division, told CNBC.

Decelerating global economic growth presents a big negative for stock prices, warns Lakshman Achuthan, co-founder of the Economic Cycle Research Institute (ECRI). "The elephant in the room remains the cyclical slowdown. And, as long as that slowdown is in play...the risk of a correction remains. It hasn't gone away," he told CNBC in a separate interview.

A Formula For Market Upheaval: The Corrections of 2018

(S&P 500 Decline, Peak to Trough, Based on Intraday Prices)

  • Jan. 26 to Feb. 9, 2018: down 11.8% across 15 calendar days
  • Sept. 21 to Dec. 26, 2018: down 20.2% across 97 calendar days

Source: Yahoo Finance

Significance For Investors

Economic forecaster Achuthan said that during an economic slowdown, the "risk of a 10 to 20 percent correction pops way up." While not predicting that the current deceleration in GDP growth will become a recession characterized by negative growth, he said: "There is more to come. It is not over."

Pinto at JPMorgan Chase also believes that "we are working towards the end of the [economic] cycle." He adds that liquidity is declining, a development that another major bank, Deutsche Bank, finds troublesome. In that environment, stock prices tend to drop further before buyers are willing to jump in. "Markets will tend to overreact to things, and you have these big moves, and then a correction to rationality," Pinto said.

Moreover, Pinto observed that computerized momentum-based trading strategies are creating selloffs that are "faster and deeper." Also, many trading algorithms have shifted to a heavily bearish stance, The Wall Street Journal has reported.

Federal Reserve Board Chairman Jerome Powell has observed that the current economy has much in common with that in early 2016, the Financial Times reports. In 2016, indicators of slowing economic growth in both the U.S. and China were weighing on stock prices. Policy initiatives in both countries eventually reversed the economic slowdowns in 2016, and stocks soared.

Today, developments in macroeconomic policy in both the U.S. and China, as well as in trade policy, hold the keys for 2019, the FT says. Fiscal stimulus has peaked in the U.S., and interest rates appear to have stabilized, but the labor market is much tighter than in 2016, meaning that the Fed is still concerned about wage inflation. In China, reining in the expansion of debt and improving the quality of economic growth appear to be a bigger priorities for the authorities than stimulating overall growth. At the same time, the threat to growth from tariffs imposed by President Trump are a current risk that was not present in 2016.

Stephen Suttmeier, the chief equity technical analyst at Bank of America Merrill Lynch, believes that stocks are still in a cyclical bear market, per CNBC. He asserted that the S&P 500 must break through its 40-week moving average, going above a value of 2,740, before he would be confident that the current correction is over, and that a new bullish cycle would be underway. The S&P was trading around 4% below 2,740 as of noon Monday.

Looking Ahead

The fact that Bank of America Merrill Lynch says stocks today are in a bear market illustrates how much damage has been done to stocks in the past quarter. Despite the January rally, stocks are still trading far below their highs and the challenges facing the market have only increased -- and not lessened. That suggests the level of risk investors face in 2019 remains high.