Wall Street Clings to Optimism Amid Ongoing Uncertainty
Happy New Year! Believe it or not, in just two months we will be a full year into the coronavirus pandemic, and all the chaos and uncertainty it has wrought. By that time, we may have a clearer picture about how things are going to shake out for the economy and financial markets in 2021. In the meantime, it’s important to continue making safety a top priority when it comes to your physical, mental, and financial health. While there are many reasons to be optimistic, there are also many challenges still ahead.
Prepare Well and Wisely for the Eagerly-Awaited New Year
If you’ve ever taken a long drive, you know it’s important to prepare mentally for the trip. For example, if you’ve ever driven from New England to Florida, you know that reaching the Florida border is exciting. Instinctively you think: “I’ve made it!” However, if your destination is on the southern end of the Sunshine State, the reality is you’ve only finished about two thirds of the trip. You still have a long way to go. That’s an important analogy to keep in mind as we near the end of a year that has felt like one long trip, indeed.
Now is the Right Time to Reassess Your Risk Tolerance
Now is a perfect time to reassess your risk tolerance with your advisor because you can use what’s been happening in the markets as an emotional gauge. Think back to when that major drop occurred in March. It was a panicked response to the World Health Organization declaring the coronavirus a global pandemic, and it affected everything. Growth-based investors saw their mutual funds shrink, but income-based investors also saw the values of their bonds and bond-like instruments drop.
Volatility Returns to the Stock Market, and May Well Stick Around
Will the Fed’s “steroids” continue to pump up Wall Street and stave off another major correction even if coronavirus cases see another major spike this fall? Or even if another relief and stimulus package is not approved? Or even if there is a lengthy legal and congressional battle over the results of the election that prolongs legislative inertia and keeps Washington stuck in the muck like a stalled Jeep?
Big Tech & the Fed are Still Keeping Wall Street Happy – For Now
Normally, when the whole stock market is at or near a record high, it means that more than half the stocks being traded are also at record highs. However, right now the opposite is true: far less than half the stocks are at record highs, and the market is largely being carried by these tech companies and a few other major players, such as large retailers who’ve adapted to the pandemic with online sales.
With Markets Holding but the Virus Still Spreading, What’s Next?
In late July, the US hit a sobering Covid-19 milestone: over 150,000 reported deaths from the virus. What’s more, many analysts say the numbers may only get worse at an increased speed. Yahoo News reported the Centers for Disease Control expects up to 11,000 more American deaths per week in August, which would bring the death toll close to 200,000 by month’s end.
Market May Keep Building Up, Blowing off ‘Froth’ for Some Time
Just as quickly as froth can build up during a blow-off top rally, it can be blown off. This happened only a week after the jobs report spike when Federal Reserve Chairman Jerome Powell said some things that were already obvious to most economists, namely that this recovery is likely to be slow, and that unemployment may still stand at between 8 and 10% by the end of the year. With that, the Dow dropped 1,800 points, its biggest drop since March.
Does a V-Shape Economic Recovery Make Sense to You?
With restrictions and partial shutdowns still in place, some businesses will have to try to get by on 50% of their normal revenue, and many simply won’t be able to do it. To me it seems likely that unemployment will still be at around 10% (at least) by the end of the year, which is slightly higher than it was at the peak of the Great Recession.
After a Calmer April, the Market is Offering a Gift to Those Who Need It.
So why is it that Wall Street rallied in April, with the markets gaining back roughly two-thirds of what they’d lost since the start of the crisis? Who knows, except we can say it was further evidence that Wall Street has been detached from economic realities for some time. Investors seemed to be cheering the progress we made in flattening the infection curve but ignoring the true scope of the economic damage being done.
Ongoing Crisis Illustrates Exactly Why Protection Should Be Priority Number One
While certain measures of the government’s relief plan will genuinely help offset the mounting impacts of the economic shutdown, others are impractical, ill-conceived, or clearly designed just to try and keep stock investors hopeful. Take the Fed’s plan for example. Lowering short-term rates to zero was smart and necessary to maintain liquidity in the banking system. As for unchecked quantitative easing, however, that move is utterly ridiculous.
Coronavirus Fear May Lead to More Extreme Volatility, or Something Worse
Prior to the coronavirus scare, the U.S. stock market had been experiencing a classic blow-off top rally, which saw it hit multiple new record highs since late October 2019. With the Fed and President Trump clearly committed to keeping the rally going by whatever means possible, 2020 looked like it might be another strong year for Wall Street—despite the fact that GDP growth has been consistently below the Trump administration’s 3 to 4% target, and is forecast to shrink further this year.
Disagreements Deepens Between Stock Market and Logical Bond Market
While Wall Street has ignored that warning sign, the bond market has been taking it seriously, and in January the 10-Year Treasury yield fell even lower, hitting 1.51% on the last day of the month.*** With the current Fed funds rate at a range of 1.5 to 1.75%, this puts the yield curve close to inverting again. In other words, the more logical bond market clearly disagrees that the economy is strong enough to justify soaring stock prices, which reinforces the likelihood that what we’re seeing is a classic blow-off top: a period of fairly steady market growth that occurs amid mixed economic data, and is often followed by a steep correction.
2020 Market Forecast: Blow-Off Top Could Last All Year Before Reality Hits
Based on history, we know that a recession typically hits 12 to 18 months after we have a flat or inverted yield curve. Since the yield curve became inverted last July, that means we should see a recession hit somewhere between August of 2020 and early 2021. However, with the Fed buying up short-term treasuries, they’re trying to ignore the logical message from the bond market that the economy is slowing, and to feed Wall Street’s irrational exuberance with more artificial tinkering. Ultimately, the Fed is trying to pretend that the yield curve was never inverted simply because they un-inverted it so quickly. The fact is, though, historically, an inverted yield curve never stays that way for very long.
New Markets Highs Suggest a Classic ‘Blow-off Top’ May Be Underway
A blow-off top is a period of relatively steady market growth that occurs in spite of mixed economic news and recessionary warning signs, and is sometimes followed by a sustained steep drop. Ironically, another indicator of a blow-off top is that much of the financial media denies when one is occurring, which happened in the blow-off periods before major market corrections that began in 2000, 2007, and going all the way back to 1929.**
Bond-Based Strategies Can ‘Soften’ the Impact of Uncertainty in Many Ways
Many agree that a synchronized slowdown for the world economy is already underway, and some are concerned that Central Banks—with their liberal use of quantitative easing since the Financial Crisis—may have seriously weakened their ability to deal with a new global recession.** With many economies in negative interest rate territory, the trade war still a factor, and political conflicts rampant in many countries (including ours), uncertainty remains high.
Is the Banking System’s Recent Liquidity Crunch a Potential ‘Iceberg’?
What’s so unsettling about this development is that no one really has a definitive explanation for how it happened. Fed Chairman Jerome Powell tried to attribute it largely to massive cash withdrawals from bank accounts to pay their September 15th tax estimates.*** To me, that theory doesn’t hold water for several reasons. One is that such withdrawals occur annually every September 15th without creating a liquidity crunch. Another is that Trump’s corporate tax cuts should have made a crunch even less likely, not more.
With the Yield Curve Fully Inverted, Is the Clock Ticking Toward Recession?
One of the arguments some economists are making for why this time will be different is that this inverted yield curve is not really being caused by a projected major slowdown in growth for the US economy, but by the global economic situation. Many countries across Europe also have inverted or partially inverted yield curves now, and even in countries where the yield curves aren’t inverted, such as Germany, interest rates are still in negative territory. Some economists say this is the real force pushing down US interest rates, more so than a slowing demand for goods and services that will trigger a recession.
More than Ever, Signs Point to Low Interest Rates as “The New Normal”
Is this latest big drop the start of that correction? To be honest, I don’t think so. In the midst of all this volatility, we’ve already had pullbacks as steep as 10% (technically a correction) and the market has always recovered; I think that will probably be the case once again. So far there’s been no materially bad news to trigger a sustained drop, but sooner or later it’s going to happen—as the bond market already knows, and has been saying loud and clear since December.
As Summer Begins, Sideways Stock Market Remains Erratic as Ever
The S&P 500 hit another new record high on July 1st, and on the same day, the Dow Jones Industrial Average also briefly topped its all-time high from October of 2018.* Ultimately, though, neither index is much higher at the mid-point of 2019 than it was at the start of 2018. On January 26 a year ago, the S&P closed at 2,872, while the Dow hit 26,616. On July 2nd of this year, the S&P was at 2,964 and the Dow at 26,678.** In the months between, the market has experienced bouts of extreme volatility, particularly through most of last year, and again in May.
Don’t Let Renewed Market Turbulence Rattle Your Summer
According to a new report by the National Association of Business Economics, a majority of economists surveyed say they believe that a recession will hit by the end of 2020, with about half of them saying they believe it will begin halfway through next year.**** Among the reasons they cite for the turning economic tide are diminishing returns from the Trump Administration’s corporate tax cuts, and the growing impact of his trade policies on US businesses and consumers. Again, all of this explains the renewed spike in volatility on Wall Street, as big investors once again have “one finger on the trigger”, ready to pull out as soon as next sustained drop takes hold.
Flat Yield Curve May Help Boost Stock Market Until Reality Hits
With a flat yield curve, many smaller banks end up tightening their underwriting standards and approving fewer loans. Naturally, that’s bad not only for the bank, but for the whole economy, and can start a domino effect toward recession. Fewer homes and cars are purchased, consumers start spending less, production falls with decreased demand, companies start laying off…on it goes. That’s how I believe this flat yield curve could quickly go from being symptom of a coming recession to being a major cause. Naturally a recession would be the worst possible news for the stock market, which dropped by nearly 60% in conjunction with the last recession.
Whether Intentional or Not, Fed’s Flattening of the Yield Curve is Bad News
In 1972, a famous accident occurred in the Florida Everglades. Eastern Airlines Flight 401 went down because its entire crew had become so focused on a burnt-out bulb on their landing gear indicator that they didn’t realize their autopilot had put the plane into a gradual descent. By the time they did notice, it was too late. Despite all their training and intelligence, they were too focused on reading one gauge to notice the bigger problem.
How Investing for Income is a “Permission Slip” to Enjoy Retirement
Now, by contrast, think about that same $500,000 invested in bonds and bond-like instruments, reliably generating $25,000 in income this year and every year for the life of the bond. Think about the fact that your $500,000 is guaranteed to be returned to you if you hold the bond to maturity and there is no default. Now think about this: in just two years, this investment could have generated enough income for you to buy your dream car in cash! In other words, it would be like having a permission slip from your wife to spend the money because you’d both know that, with this strategy, the income is a renewable resource, much like wind or solar power.
Markets May Shake Off Bad News for Quite a While…Or Not
In truth, what we’re seeing with the markets now is not uncommon from a historical perspective. Investors typically fall into a trend of shaking off bad news toward the end of a cyclical bull market period, and—as I explained in my 2019 market forecast last month—I believe we’re at such a period. I’m forecasting a second straight year of losses for the stock market, and an economic slowdown that could lead to a new recession by 2020. Whether we’re in the early stages of the third major sustained market correction of this secular bear market remains to be seen, but it’s certainly possible.
Forecast: Will Markets Rebound in 2019 or is More Chaos in Store?
Last month was the stock market’s worst December since the Great Depression. The turmoil was largely due to the Federal Reserve moving forward with another short-term interest rate hike despite the growing threat of a flattened yield curve and more criticism from the Oval Office. The Fed has stated it hopes to approve three additional short-term interest rate increases next year, and while many forecasters are saying that will happen, I say it won’t.