After the correction in December, we’ve been on a tear with the S&P shooting up over 20%.
What is the landscape telling us now? Where are we headed in the next few years and why?
Here are some things about the market that’s been on my mind.
Inverted yield curve
That’s right. The yield curve inverted. Specifically, the 2-year and the 10-year Treasury.
An inverted yield curve means that the interest rate on the 2-year is higher than the interest rate on the 10-year.
Investors are fearful that we will be in a worse position then than we are now. The other, more important part, of an inverted yield curve, is that’s it’s preceded every recession.
However, that recession doesn’t usually start for another 18 months - 2 years. Between now and then, we usually see a significant amount of growth.
Another thing to point out is interest rates.
When a recession hits, the Federal Reserve (FED) reduces rates. This makes borrowing less expensive for consumers and corporations, encourages spending, and gets the economy moving again.
Over the last three years, the FED has been raising rates. The economy has been strong so they raised rates to keep inflation at bay.
With December’s correction and lower growth anticipated, prominent economic figures want the FED to cut rates by .50%, or 50 basis points.
They are hoping to keep the current bull market intact with this cut. Here’s the drawback to cutting interest rates. When the recession hits (notice I said when), the FED will need to cut rates for reasons I mentioned earlier.
If rates aren’t high enough, they can’t cut them enough to stop the bleeding and the economy, and the market will continue down.
Long-term demographic challenges
In case you haven’t heard, the whole world is getting older. Hyperbole aside, other than the United States, the other developed nations around the world aren’t having enough babies to replace the older generations.
This bad for two reasons:
- The United States isn’t the only country that has Social Security - Many other countries around the world have a similar program. If there are more old people than young people, these types of social programs will be underfunded. This will hurt current and future retirees.
- When people retire, they tend to spend less than they did when they were working. Consumer spending is a driver of economic growth. With fewer young people around to make up for that, consumer spending will decline which will hurt economic growth.
For more on this area and a few others, I highly recommend giving this podcast episode a listen.
Current debt levels are the highest they’ve ever been. Student loans total well over $1 trillion, consumer debt totals over $1 trillion, and auto debt recently crossed over the $1 trillion
Here’s why that matters. We’ve already discussed that the FED lowers interest rates to promote borrowing, which catalyzes spending. Corporations and consumers borrow money because it’s extremely cheap to do so when interest rates are low.
As the economy gets stronger, inflation will start to rise. The FED will raise interest rates to try and keep inflation relatively low. Some inflation is good.
Likewise, mortgages, auto loans, and personal loans will also have higher rates.
Those rates will keep rising and debt will continue to get more expensive to service until people fail to make payments. This causes an avalanche of defaults. People sell investments to create the cash needed to pay off debt. Stocks start to slide and other people exit their positions to avoid further losses. And on it goes.
What’s my point with all of this? My view of the current market is that we will see some sort of significant pullback in the near future. That could be anywhere from 2-4 years.
Beyond that, however, I think the United States will continue to be the little engine that could for global economic growth. China will play a key part here as well, but with many countries getting older, international investment opportunities will dwindle.
If you'd like to learn more or have questions about what was discussed here, send me an email!