U.S. stocks ended this past week on a positive note, or at least that’s how it seemed. The problem is that every time we have a few big up days in stocks, I get this feeling that it will directly correlate to the number of people who will be devastated in the end.
I believe this is a suckers rally. It will only serve to quell some fear that has been recently lingering. There may be more rallies before this whole thing is over. After all, it took two years after the inversion of the yield curve in 2006 before things really fell apart.
When you look back, we were already in a recession at the beginning of 2008, but people didn’t know it yet. It was really September 2008 when the wheels fell off, but the official recession is recorded as beginning in December 2007.
The yield curve is mostly inverted. The most relevant portions of it are inverted. I don’t care all that much about the 10-year yield versus the 2-year yield. I think it is more significant that the 10-year yield is below the 3-month yield. The 30-year yield was below the short-term yields for a short time, and it is now close to flat.
The interesting thing to me is that some people are actually talking about it. Some people are actually daring to mention the “R” word – recession. It isn’t being touted in any official Federal Reserve statements, but you will get some mention of a recession possibility on well-known websites and on CNBC.
Now throw this into the mix. Former New York Fed president, William Dudley, actually said that the Fed should not bail out Trump for his tariffs. He said that if the goal of monetary policy is to achieve the best long-term economic outcome, then Fed officials should consider how their decision will affect the political outcome in 2020.
If Dudley is thinking this, I can’t imagine that current Fed officials are not. They did lower the target federal funds rate at the last meeting. I don’t think they want to get at Trump so much as they do not want the brunt of the blame when things go bad. Neither does Trump, which is why he is preemptively blaming Powell and the Fed for being too tight.
Jerome Powell is a bureaucrat and an establishment shill. Trump should have known this when he appointed him as Fed chair. Maybe Trump did know. It makes it all the easier for Trump to pick a fight with him now.
I am sure Powell despises Trump at this point. Trump beats up on Powell on Twitter, and Powell is forced to sit there and take it. I suppose that Powell could respond, but he is a scared bureaucrat, and he doesn’t want to disrupt things more. He is probably hoping that Trump loses in 2020. He’s not likely to get reappointed either way. But Powell is not going to try to sink the economy, or at least not make it obvious that he is trying to sink the economy. This is why he’ll go along with a one-quarter point rate cut to the federal funds rate. It won’t stop a recession, but it makes it look like he’s doing something.
The Great Crash
There are similarities to 2007/ 2008 right now, but there are also differences. I expect housing prices to go down significantly in many areas at some point, but I doubt it will be as severe as the previous housing bust. That is the good news.
The bad news is that we are worse off in many ways. The monetary inflation from 2008 to 2014 was bigger than anything we have seen in the U.S. since the creation of the Fed. Some of this was kept in check by the massive excess reserves piled up by the commercial banks. But the loose money and low interest rates have massively distorted the allocation of resources.
The national debt is ridiculously higher than it was. We may see a one trillion dollar deficit in fiscal year 2020 even without a recession. It is getting to the point of absurdity, and it makes you wonder how this whole thing will unravel. I don’t know how it will unravel, but I expect it to unravel quickly once it gets going.
The banks have already seen massive bailouts. They were bailed out directly in 2008 and 2009. This infuriated much of the American public, although not enough for any kind of serious consequences. So the Fed started bailing out banks by buying up mortgage-backed securities and by paying interest on bank reserves. I guess this could be seen as good news in the sense that many banks should not be quite as brittle in the next recession.
And then there are stocks. I believe this is the massive bubble. I am not counting bonds because I don’t think bonds are going to unravel in the immediate recession. If anything, rates will go down.
Stocks have exploded since March 2009. It is an unprecedented bull market that has lasted for over a decade now. It is going to crush some people who have based their future plans on a retirement portfolio that is heavily in stocks.
These people could get out now, or at least some of them could. But most of them won’t. They are sold a line that they should buy and hold and stay in it for the long run.
What if we see U.S. stocks crash by 80%? Will we still hear people advising to buy and hold? Actually, the advice might be more appropriate at that time, but it will have already devastated anyone already following that advice.
Buyers and Sellers
When stocks go down, we hear that there is a “sell-off”. Or we hear that the people are selling today.
I am not faulting anyone for saying this, but it is important to note that this is not precise language. That is because whenever a stock is traded, there is a buyer and seller. There may be more than one buyer and/ or seller, but there is a buyer to match each seller for each share. In order to sell stock, you have to have a willing buyer.
The key is the price. You could own a stock that is “worth” $100 per share. But this is really just the price that it was last traded. It doesn’t mean you can get this price if you want to sell.
You could have many willing buyers, but maybe they are only willing to buy for $80 per share. So it isn’t really a question of how many buyers and sellers there are. It is a question of what price they are willing to buy and sell.
The reason I bring this up is because stocks can fall in price very quickly. If the sentiment turns, then things can get ugly. Stocks can go up for 10% per year for several years and then get wiped out in the matter of weeks or days if the news is bad enough.
The inverted yield curve is telling us that a recession is ahead. I believe the bond investors. The bond market is smarter than the stock market. Of course, markets don’t have brains, but the people buying and selling in them do.
There are many stock investors who have their accounts on autopilot. Think about someone with a 401k. They have a certain amount from each paycheck going into their account. Some people have all, or a good portion, of their money going into mutual funds made up of stocks. This is not as much the case with bonds.
There are millions of Americans who are relying on a healthy stock market in order to retire. If you are 25 or 30 years old, it is probably not a big deal, unless you were planning to retire really early. But for people who are in their 40s and 50s, and even older, they are going to be devastated if they have staked their future plans on the wealth derived from stocks.
When I see these big up days for stocks, I know that it will mean even more pain on the way down. I think it is wise to plan for a drop in stocks of at least 50%. If this makes you nervous, then do something about it. With the massive bubble and the time that has gone by, I don’t think it would be impossible to see a fall of 80%.
When that happens, I may just buy and hold for a while. That’s when everyone will have stopped recommending that strategy.