By Richard Morey
Look out below…
The Stock Market
TRENDING DOWN: In January it looked – to me anyway – as if the long-awaited stock market downturn was beginning in earnest. This has now been confirmed and reconfirmed. The stock market bubble is popping.
Through April, here are the monthly and year-to-date returns for the 3 major U.S. stock market indexes
Western European stocks have fallen somewhat less, while China’s markets continue to struggle, with the Shanghai Composite index down 18% year-to-date. Then we have Eastern European stocks down roughly 72%
I see several more quarters like the last one coming to the U.S. stock market. The first quarter was, from my perspective, a modest beginning. There will of course be a number of significant rebounds along the way, but at the end we’re likely to approach actual “fair value” for stocks. By any reliable measure the current stock market is at least one of the three most over-priced in our nation’s history. This means fair value is far below the prices being quoted today.
Keep in mind that most stock market investors aren’t even worried yet. In fact, the remarkable thing about the stock market thus far is the lack of fear we’ve seen even as stocks have fallen into correction territory for the broad market and a bear market for tech stocks.
I have attributed this lack of fear (which you can clearly see in the “fear index” for stocks called the VIX) to the unprecedented positive momentum for stocks that developed as the market morphed into the largest bubble in history. This doesn’t imply the fear isn’t coming, and when it does the losses stocks suffered in April should pale in comparison.
The Bond Market
Through the first four months of the year the broad U.S. bond market fell 10%. This is the largest drop for bonds since inflation ravaged the economy in the late 1970s. The bond market needs, and is demanding, for the Fed to start aggressively raising interest rates. This is the one proven way to tackle inflation. It will work by pushing the economy into recession. This will stop inflation in its tracks because people won’t have the money to spend at higher prices. Interest rates will then go back down, and bond prices back up.
Raising interest rates is the only way anyone has ever found to combat inflation. This medicine is, however, quite distasteful to economic growth. In fact, the entire purpose is to slow down lending and spending. The Fed members are now loudly declaring their intention to begin raising rates aggressively at upcoming meetings. They appear to be waking up from their year-long slumber – during which time inflation led all workers to suffer a 3.7% decline in their inflation-adjusted paychecks (the largest such drop since 1980). The economic hardship due to inflation is even worse for our 70 million retired workers.
Perhaps we could raise interest rates without derailing economic growth if the domestic economy had strong momentum & few headwinds, and the world economy didn’t face large risks. This clearly is not the case today. In his most recent quarterly report Dr. Lacy Hunt listed six headwinds to U.S. growth. Note these are all occurring before the Fed acts to restrict growth. The six headwinds are:
First quarter GDP came in at a negative 1.4%. You’ll be forgiven if you didn’t hear about this fact, as the media outlets hardly reported on it except to note the drop in exports should be short-lived.
Reading the Bureau of Economic Analysis report on GDP , I was struck by how much of the contraction we saw was directly due to reduced government spending. This is Lacy Hunt’s last point above. We went from $2 trillion annualized in “free” money to consumers and businesses last year to… close to nothing today.
As a result, unless Congress should turn on the money spigots again and start sending out checks to everybody, expect the fourth quarter of last year to be the high-water mark for the economy. This time around, instead of having the most accommodative Fed of all time – we have the polar opposite. The Fed must raise rates to counter inflation. They must act, and I believe this will bring the economy down – hard. Stocks will fall in tandem with the economy – or will continue to anticipate the economic slowdown.