The S&P 500 index recently surpassed the 6,000 mark, even though it just closed the day slightly below that.  The Dow is closing in on 45,000.  The Nasdaq is above 19,000 and about 5% away from hitting the 20,000 mark.

I thought it was crazy a couple of years ago when the S&P 500 was at 4,000.  It is now 50% higher from there.

Gold recently hit all-time highs near $2,800 per ounce, but it has pulled back since the election.  Bitcoin is nearing the $100,000 mark.

This could be the mother of all bubbles.  That is particularly the case for stocks.

I thought we were in a bubble in 2019 and 2020.  The prices have roared a lot higher since then.

The Yield Curve

The yield curve has been mostly inverted for all of 2023 and most of 2024.  It has recently flattened quite a bit.  The current yields are as follows:

• 3-month yield = 4.62%
• 2-year yield = 4.21%
• 10-year yield = 4.27%
• 30-year yield = 4.45%

One more rate cut from the Fed should put the short-term rates below the long-term rates, which is where they normally are.

The inverted yield curve is when long rates are less than short rates.  This is a recession indicator.  But the key point here is that the recession doesn’t typically come until the inverted yield curve reverts to normal.  We are in that process now.

This is happening as stock indexes hit all-time highs with extraordinary gains.  It is an understatement to say that stocks are vulnerable right now.

Timing and Severity

While we are likely to see a recession and a reversion to the mean in terms of stock returns, we don’t know exactly when it will happen and how severe it will be.  With the massive gains we’ve seen in stocks over the last decade and a half, a reversion to the mean would mean big negative returns.

Even with that, we have no idea what the reaction will be.  Will the government throw more money at the problem?  Will the Fed reignite monetary inflation?  It may not matter what the Fed does in the short run.  When sellers want to sell and are willing to accept a much lower price for the sake of getting out, then stock prices will go down.

The reaction from the Fed will have an impact on how things take shape down the road.  A return to monetary inflation will likely lead to more price inflation down the road.  If the Fed has a milder response, it will be a more painful recession even though it is the long-term medicine that we need.

Again, a strong Fed response will not necessarily save the stock market from its plummet downwards, but it will impact things for years in the future.

Right now, it seems like stocks are destined to always go up no matter what the news brings.  This is when it is the most dangerous.  There is complacency out there.  There is also arrogance.  It will not last forever.