Amid the current market volatility, it’s easy to forget that in January we enjoyed calm seas and record gains. At the time, on Friday, January 26, the stock market was about to break the all-time record for the longest streak without a 5% decline in 1959. That would have been done later in February. In October, the S&P 500 eclipsed the record for consecutive days without a 3% drop and built on it with each passing day. Volatility, as measured by the VIX index, had recently reached record highs. The average open/close spread of the market was 0.3%, the lowest since 1965. What could disturb this sea of windfall tranquility? Plenty!
Everything was deleted a week later. On Friday, February 2, the 3% streak came to a halt as the market fell 3.93% below the intraday high reached on January 26. With a better-than-expected jobs report (200,000 vs. 180,000 expected) on Feb. 2 and the fastest clip growth since the recession, fears were widespread that a new growth outlook would force the Fed to raise rates. more aggressively than advertised. The following Monday’s 4.60% decline made it clear that what began as an organized exit from high-dividend-yielding stocks had turned into a broad-based market rush. It didn’t help that perfectly priced frequent flyers such as Google and Apple had disappointing revenue reports.
The February 5 decline ended the market’s quest for the longest streak without a 5% decline. It was the worst drop since Aug. 8, 2011, down 4.62% at the time, and the worst one-time drop in Dow Jones history at -1175. The VIX index, which had been established at 11.08, rose to 37.32. It could have been worse. The Dow was down 1597 points by mid-afternoon. Two weeks after the market closed in record territory, it suffered a correction.
Those who had been lulled into complacency had a rude awakening. This silent market was not the new norm, but it may have been a fabulous lull before the storm. So, entertaining people re-immersing themselves in the market may want to steer clear. Despite the rally since, what started as a knee-jerk reaction to rapidly rising bond yields could turn into something far more detrimental. Indeed, a financial storm is brewing and, like the record calm that preceded it, it will be of historic proportions. What we have witnessed so far are only the first pangs of childbirth. The recent spike in volatility reflects the paradigm shift with 1% more days – a rarity the year before – coming 48% of the time.
The causes of the emerging storm have little to do with our much-hyped bloated national debt, the Fed’s lofty balance sheet, or the collapse of the dollar. The first two may come into play to some degree once the collapse is underway, but we’ve been hearing about them for years to no avail. The third is unlikely to materialize. No, the forces involved are more tangible, certain and have a more predictable timetable. Their effect will soon manifest itself in the market. Of course, soon is relative.
Human beings go through life cycles and, combined with demographics, they help us predict future economic trends. Unfortunately, this combination predicts a steep spending deficit that will have disastrous consequences for our economy and our stock market. What is the shortfall? Approximately $686 billion cumulative total from this year through 2023. We all know that every dollar spent multiplies many times over in our economy. This is what we call the velocity of money. When this is taken into account, the figure is at least $3.43 trillion. Ouch! That’s more than double the 10-year, $1.5 trillion revenue cut from Trump’s tax plan – the Tax Cuts and Jobs Act – and just shy of the $3.654 trillion dollars the U.S. government is expected to receive this year, according to the Office of Management and Budget.
Let’s put these numbers into perspective. During the Great Recession, the federal government spent about $3.40 trillion to stimulate the economy from $614 billion in lost commodity spending and about $1 trillion in property losses. Yes, you read correctly. It took more than twice as much federal spending to offset consumer losses in spending and real estate. And such inefficiency is normal. With the same multiplier, it will take a government package of $7.22 trillion to deal with this new shortfall for the economy. That’s two years of personal income taxes, corporation taxes, and Social Security and Medicare taxes combined! If that’s the size of the package, imagine the size of the financial storm. It will eclipse the financial crisis and last twice as long.
If you are invested in the stock market, your portfolio will be very successful. Therefore, it would be wise to change future allocations and start limiting your equity exposure now. Many will call me irresponsible, but when what I predict comes to pass, you’ll want to be completely out of the stock market.
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