Outsider Club’s Weekly Reader Question
“Stocks got hit hard and headlines about a weak economy and the Fed reversing course are all over this week. Is this just another scare with a rebound right behind it?”
— Christopher T.
NICK HODGE | Founder
It certainly feels like we’re at a crossroads.
U.S. stocks just went through their best quarter since 2012, with the S&P 500 up ~14% so far this year. Granted, that comes after losing 15% in the last quarter of 2017.
So, really, we’re just back to where we were last October, which is why it feels like something is going to give. Are we going to go back to the highs seen last September? Or are stocks going to repeat their Christmas nightmare?
My crystal ball is in the shop. But with the Fed recently turning ultra-dovish, stocks have responded well. With the current Fed funds rate at 2.5%, it has some room to start cutting again. My view is U.S. stocks can move higher as long as the Fed can cut.
Once the Fed is truly out of bullets, i.e., it goes back to zero rates with no room to go, then we can start talking about a real retracement in stocks.
In short, we can rebound until the Fed can’t jump.
ADAM ENGLISH | Editor
I certainly wouldn’t rule out a rebound after the initial wave of bad news, but I’m convinced that we’re rapidly approaching a significantly long downward trend in the stock market.
I wrote more extensively on this on Tuesday, but the inverted yield curve is not a good sign. It shows a profound distrust in the stock market and the economy over the short term.
Keep in mind that “short term” is relative. Right now, the two-year Treasuries yield is higher than the five-year Treasuries.
The fact that yield curve inversions can predict recessions aside, I think this is the beginning of a breakdown of abnormally low yields on bonds and abnormally high risk tolerance due to the Fed’s policies over the last decade.
It fueled a massive increase in government and corporate debt. Total government debt went over $65 trillion in 2018, up $37 trillion from a decade ago. Non-financial corporate debt went over $72 trillion last year, now near an all-time high of 92% of GDP.
This bond-and-debt bubble has to deflate or we have to grow into it. The latter will take so long at current growth rates it seems like the former is very likely to happen.
I don’t think it will pop. I think it’ll be a grueling, slow burn as it unwinds, and that will be reflected in a bear market over several quarters or several years.
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