It’s Not Over

Amidst the market’s current volatility, it is easy to forget that back in January we enjoyed record calm seas and gains. Back then, on Friday, January 26, the stock market was on pace to break the all-time record for longest streak without a 5% decline set back in 1959. It would have been a done deal later in February. Back in October the S&P 500 eclipsed the record for consecutive days without a 3% drop and was building on it with each passing day. Volatility, as measured by the VIX index, had recently hit record lows. The market’s average open/close difference had been 0.3%, the lowest since 1965. What could possible disrupt this windfall sea of tranquility? Plenty!

That was all done away with a week later. On Friday, February 2 the 3% streak was stopped cold as the market went 3.93% below the intraday high reached January 26. With a better than expected jobs report (200,000 vs. the expected 180,000) February 2 and wage growth picking up at the fastest clip since the recession, there was widespread fear that renewed growth prospects would force the Fed to raise rates more aggressively than advertised. The next Monday’s 4.60% drop made it clear that what started out as an organized exit from high dividend yield stocks had turned into a stampede for the entire market. It did not help that priced-to-perfection high flyers such as Google and Apple had disappointing earnings reports.

The February 5 drop brought to a close the market’s quest for longest streak without a 5% decline. It was the worst decline since August 8, 2011, 4.62% back then, and the worst point decline in Dow Jones history at -1175. The VIX index, which had stood at 11.08, climbed to 37.32. It could have been worse. The Dow was down as much as 1597 points by mid-afternoon. Two weeks after the market had closed in record territory it went through a correction.

Those that had been lulled to sleep by complacency got a rude awakening. That whisper quiet market ride was not the new normal but it may have been a fabulous lull before the storm. So, those entertaining diving back into the market might want to hold off on that. Despite the recovery since, what began as a knee-jerk reaction to rapidly rising bond yields may turn to something far more nefarious. Indeed, a financial tempest is coming and just like the record-breaking calm before it, it will be of historic proportions. What we have witnessed thus far are just the initial birth pangs. The recent rise in volatility is testimony to the paradigm change with 1% plus days – a rarity the year before – coming 48% of the time.

The causes of the emerging storm have little to do with our much-publicized ballooning national debt, the Fed’s high balance sheet or the collapse of the dollar. The first two may come into play to some extent once the meltdown is under way but we’ve been hearing about them for years to no avail. It is unlikely the third will materialize. No, the forces involved are more tangible, certain and have a more predictable timeline. Their effect will be manifested in the market soon. Of course, soon is relative.

Humans go through life cycles and when combined with demographics they help us predict economic trends ahead. Sadly, this combination is predicting a pronounced shortfall in spending that will have dire consequences on our economy and stock market. How big a shortfall? About $686 billion cumulative total starting this year and going through 2023. We all know that every dollar spent multiplies itself several times in our economy. This is what we call the velocity of money. When that is taken into account the figure is at least $3.43 trillion. Ouch! That is more than twice the ten-year revenue reduction, $1.5 trillion, from the Trump Tax Plan – The Tax Cuts and Jobs Act – and just a touch lower than the $3.654 trillion the U.S. government is forecasted to take in this year, according to the Office of Management and Budget.

Let’s put these figures in perspective. During the Great Recession, the federal government spent approximately $3.40 trillion to stimulate the economy from $614 billion in lost staples spending and about $1 trillion in real estate losses. Yep, you’re reading it right. It took more than twice as much federal spending to make up for consumer losses in spending and real estate. And such inefficiency is normal. Given the same multiplier it will take a government package of $7.22 trillion to deal with this new shortfall to the economy. That is two years-worth of individual income taxes, corporate taxes, and Social Security and Medicare taxes put together! If that is the size of the package, imagine the size of the financial storm. It will dwarf the Financial Crisis and last twice as long.

If you are invested in the stock market your portfolio will see a big hit. Therefore, it would be wise to make changes in future allocations and to start limiting your exposure to stocks now. Many will label me as irresponsible, but when what I predict takes hold, you will want to be out of the stock market altogether.