The S&P 500 continues to rise on the eve of the new presidency. The promises of lower taxes, fiscal stimulus from infrastructure spending, decreased governmental regulation and repatriated offshore corporate cash have many investors very excited. Why then do some analysts write about how to prepare for the next stock market crash? Money Morning says there is stock market crash coming and you should consider your investments based on that fact.
The S&P 500 and Nasdaq both broke record highs last week (Jan. 6) as the Dow nears a record 20,000 points. But with stocks soaring, the possibility of a stock market crash coming is on the rise, too.
The stock market crash of 1929 was brought on by a stock market bubble.
Simply put, investors bought up stocks because they thought the markets would only go up. This led to investors taking risks they couldn’t afford to.
Amateur investors borrowed $8.5 billion (in today’s dollars) to buy stocks with. As long as stocks kept going up, everyone was making money. And as long as more people were buying stocks, prices continued to soar.
But when prices began to fall, these investors were forced to sell, sending prices in a downward spiral.
The collapse of the stock market led to an 86% drop in the value of the Dow between September 1929 and June 1932.
The same thing happened with the dot com bubble and the 2008 market crash. Initially there are good fundamental reasons to invest in undervalued stocks. And then stocks outrun their fundamentals but keep rising in price. Over-enthusiastic investors keep buying simply based on a rising market. This is a recurring theme. So, how do you prepare for the next stock market crash? What do you watch for?
Will Supply Side Economics Work This Time Around?
In the 1980’s supply side economics helped drive the economy and market to new highs. The same approach did not work out so well in the first years of the new millennium as witnessed by the market crash and Great Recession of 2008. The New York Times writes about how Trump can’t make it 1981 again.
Indeed Mr. Trump’s advisers say that over the next decade, their plans for tax cuts and deregulation could push the average annual growth rate back up to 3.5 percent – the same as during the Reagan presidency. Mr. Trump says the country can grow even faster. His backers dismiss skeptics as defeatists and have insisted there is “no law of nature or economics” that would prevent the United States from reviving the boom of the 1980s.
Only there is such a law. The forces that underlie economic growth have weakened significantly since the Reagan years, worldwide. No nation, no matter how exceptional, can try to grow faster than economic forces allow without the risk of provoking a volatile boom-bust cycle.
For those who are still pouring their money into the stock market this article bears reading. Population and productivity per worker are the factors that drive growth. In the 1980’s both population and productivity went up at about 1.7% a year and the economy grew by 3.5% a year. The US population today is growing by 0.7% and Trump wants to deport workers (illegals) which would reduce the already low growth rate. Trump supporters say that his other measures such as bringing corporate cash back to the USA will easily double the productivity increases of the 1980’s. What happens when repatriated corporate cash is used for takeovers and not to create jobs? Our suggestion is that to prepare for the next stock market cash you increase your cash position and look at stocks like Johnson & Johnson that do well no matter which way the market is headed.
A new president is about to take office. Successful investors will be the ones who anticipate how the next administration and congress will affect the economy and how the various factors at play will affect investments. In the case of Trump and a Republican controlled congress we expect tax cuts, an attempt to bring corporate cash back from overseas and increased spending on U.S. infrastructure. If these plans come to fruition there will be at least short and medium term stimulus to the economy. A predictable result will also be increased interest rates, namely a tighter monetary policy. The value of the dollar will rise versus other currencies. Our concern today is what impact would tighter monetary policy have on your investments? Bloomberg writes about the outlook on the Fed, Trump and the dollar.
PKO Bank Polski, which topped Bloomberg’s overall accuracy rankings for the final quarter of 2016, sees the dollar’s rise pushing the euro to 95 U.S. cents or even lower by the end of June, a level not seen in 15 years. That’s the lowest call for the pair among 53 forecasters, according to data compiled by Bloomberg.
The forecast is based on the prospects of a tighter monetary policy from the Federal Reserve, coupled with markets expecting President-elect Donald Trump’s fiscal measures to “translate into higher growth and inflation,” said Jaroslaw Kosaty, the chief FX strategist at the bank, Poland’s biggest.
Will the impact of tighter monetary policy be solely because of a stronger dollar? How will inflation be affected if the Fed does not raise rates rapidly enough?
How Fast Will the Fed Hike Rates?
The Federal Reserve has been criticized by some, including the incoming president, for moving too slowly to raise interest rates. Now one of the Fed’s members calls for faster interest rate hikes according to Reuters.
Boston Fed President Eric Rosengren on Monday called for the U.S. central bank to step up its pace of interest rate increases from the once-a-year pattern it has pursued since 2015, warning of inflation risks if it does not.
“I expect that appropriate monetary policy will need to normalize more quickly than over the past year,” Rosengren told the Connecticut Business and Industry Association.
At 4.7 percent, unemployment is at a level that is sustainable over the long run, he said, and inflation is on track to reach the Fed’s 2 percent target by the end of this year. If the unemployment rate falls further, he said, inflation could overshoot that target, “which would place the economic recovery at risk.”
Tighter monetary policy in the form of higher interest rates may come sooner rather than later. This will drive up the interest that your CDs earn at the bank and the rates on US Treasuries. It will hopefully forestall inflation but if the Fed does not act fast enough the value of your savings will be eroded. Companies that export will be hurt as international sales fall off. And, if Trump starts a trade war, all bets are off and you may just want to convert everything to cash and put it under your mattress!
On the eve of Trump’s inauguration the stock market is up and many are enthusiastic about tax cuts, repatriated corporate cash and the fiscal stimulus associated with fixing much of America’s broken infrastructure. We wrote about stocks at risk in the Trump years but there may be more. Lawrence Summers, former Harvard Prof. and Secretary of the Treasury during the Clinton years, believes that markets are underestimating risks associated with a Trump presidency. Bloomberg reports.
“This is probably the largest transition ideologically and in terms of substantive policy that we’ve seen in the U.S. in the last three quarters of a century,” Summers told Tom Keene in a Bloomberg Television interview Tuesday. “Those kinds of transitions have to be – given the central role of the U.S. in the global system – matters of enormous uncertainty. I don’t think that’s fully recognized by markets.”
This concern is compounded by the people Trump has advising him. Peter Navarro (head of the White House National Trade Council) and Wilbur Ross (Secretary of Commerce) have written a report that Mr. Summers calls beyond voodoo economics and the economic equivalent of creationism because it is so far from responsible economic thinking. Summers does not believe that repatriated corporate cash will create new jobs.
“The vast majority of the companies who have large overseas cash also have substantial amounts of domestic cash,” he said. “The reality is that cash that is brought home will be used to pay dividends, to buy back shares, to engage in mergers and acquisitions, to rearrange the financial chessboard, not to invest in large amounts of new capital. It is a chimera to suppose that there will be large increases in capital investment as a consequence of that repatriation.”
Summers believes that the Trump years will be ones of extraordinary uncertainty for the markets and lead to extraordinary risk.
Doing Business in the Era of Trump
It would appear that every business decision by every US company is now subject to a tweet from the incumbent president. A recent example is GM’s need to increase production of its popular and hot selling Chevrolet Cruze. Orders are up and the main factory in Lordstown, Ohio cannot keep up with demand. One of the Cruze models is a hatchback made in Mexico and sold around the world. Out of 190,000 Chevy Cruze vehicles sold in the USA last year just over 4,000 were made in Mexico while 30,000 of the Mexican vehicles were sold around the world. It would seem to make good business sense to use an existing facility to catch up with increased demand rather than try to build a new factory in Ohio which would not be ready for a couple of years. But, according to The Washington Post, the next president targets General Motors over its plans to import a few thousand cars from Mexico.
President-elect Donald Trump reiterated Tuesday his threat to impose punitive new tariffs on imports, singling out General Motors for assembling some of its Chevrolet Cruze models in Mexico and selling them in the United States.
“General Motors is sending Mexican made model of Chevy Cruze to U.S. car dealers-tax free across border,” Trump tweeted. “Make in U. S. A. or pay big border tax!”
These strong man tactics may play well to the folks who voted for Trump but the extraordinary uncertainty that his tactics cause may well lead to extraordinary market risk.
The night of Trump´s election the stock market tanked and then revived as investors thought about lower taxes, offshore corporate cash repatriation and infrastructure-related economic stimulus measures. An already over-priced stock market headed up. But in the last two weeks the market has started to oscillate up and down with the Dow Jones Industrial Average falling 140 points at the ending of the session end half a percent below the previous day´s close. What is happening to the stock market rally? CBS Money Watch looks at hot stocks that are suddenly not.
Rising bond interest rates are sapping the popularity of high-yielding stocks.
For the first half of the year, the S&P 500 sectors most sensitive to interest rates seemingly traveled in only one direction: up, drawing both institutional and mom-and-pop investors to the stock market to buy telecom, utilities and real estate investment trusts, known as REITs. The appeal was their high dividend yields.
But in keeping with Isaac Newton and his theory on gravity, the darlings of the 2016 markets have fallen back to earth.
Rising interest rates explain the faltering of dividend stocks but what else is going on?
Is There a Trump Speed Bump Ahead?
The stock market anticipates gains and losses in stock prices. CNN Money writes about a potential speed bump for the stock rally.
Trump’s victory led to an explosive rally in stocks of financial, health care and industrial companies.
Investors are betting Trump and the Republican-led Congress will roll back some Wall Street and health care reforms put in place under President Obama, cut taxes and approve $1 trillion in stimulus for roads, bridges and other infrastructure.
But has the stock rally gone too far too fast?
It may be that the so-called Trump bump has already eaten up potential gains for 2017. For the market to maintain and move ahead next year the market needs to perform despite higher interest rates. Trump needs to deliver on his promises which will mean making congress go along. And we all need to hope that the new president does not start a trade war that extinguishes global as well as US economic growth.
A Voice of Concern from the Heartland
Mr. Trump won the election despite winning less than half the votes because he dominated in states across America´s heartland. Now the same folks who voted for him are concerned about the price of a trade war with China. The Delta Farm Press discusses the issue.
The late President Dwight Eisenhower had a sign in his office on his farm in Gettysburg, Pa., that said: “Farming looks mighty easy when your plow is a pencil, and you’re a thousand miles from the corn field.”
The same might soon be said about trade negotiations, a subject that could play an increasingly important role in whether U.S. farmers are able to enjoy higher prices for their crops in the near future.
Trump named Peter Navarro, author of the book, “Death by China,” and a frequent critic of China’s economic policies, to head the newly formed White House National Trade Council, removing any doubts that he intends to take a tough stance on relations with China.
The two primary objects of retaliation by China in a trade war would be the two largest exporters, Boeing and U.S. agriculture. The agricultural states in the heartland are the ones who voted Trump into office. What is happening to the stock market rally is that investors may be waking up the concerns of farmers, Boeing and defense contractors who seem to be on Trump´s hit list.
When it was clear that Trump would be the next president the stock market tanked. Then investors thought of the promises of lower taxes, corporate money repatriated from offshore and fiscal stimulus via infrastructure repairs. And the stock market rallied. Now the specter of a trade war emerges as Trump’s trade policies become clearer. Will Trump’s trade policies kill his stock market rally? Will they kill the American economy? The Huffington Post writes that that stocks could suffer as Trump’s trade policies take shape.
The year-end stocks rally on the heels of the election of Donald Trump as U.S. president was built on expectations of reduced regulations, big tax cuts and a large fiscal stimulus.
Now signs are emerging from the Trump camp that harsher trade policies could jeopardize the honeymoon are likely in the offing, and investors would be well advised to give those prospects more weight when gauging how much further an already pricey market has to run.
By naming China hawk Peter Navarro as head of a newly formed White House National Trade Council, the incoming administration is signaling Trump’s campaign promises to revisit trade deals and even impose a tax on all imports are very much alive.
The policy that has investors worried is the so called border adjustment tax. Deutsche Bank analysts expect this policy would drive up inflation causing the Fed to raise interest rates faster than expected and drive the dollar up 15% against other currencies. For every 5% that the dollar goes up the earnings of S&P 500 companies go down 3%. A 15% rise in the dollar would translate into a 9% drop in S&P 500 earnings. Will Trump’s trade policies kill his stock market rally? It looks like that could be the case.
Can the USA Withstand a Trade War?
Talk is cheap. An opening gambit for Trump may be to talk tough in order improve trade relationships for the USA. But what happens if the other side responds by upping the ante? Project Syndicate discusses Trump’s gathering trade war with China and others. Trump’s picks as commerce secretary and national trade council are indicative of the direction Trump wants to go. Wilbur Ross and Peter Navarro are trade hawks who are ready to abrogate any and all trade deals.
[S]uch tough talk undoubtedly played well with voters, it fails a key reality check: America’s large trade deficit – a visible manifestation of its low saving – calls into question the very notion of economic strength. A significant domestic saving deficit, such as that which afflicts the US, accounts for America’s insatiable appetite for surplus saving from abroad, which in turn spawns its chronic current-account deficit and a massive trade deficit.
The USA runs a trade deficit with a 100 nations. The author of this article likens the fix of US trade relationships to the Dutch boy putting his fingers into the leaks in the dike and finding out he does not have enough fingers! The USA and China especially are locked into a co-dependent economic relationship and a trade war could be devastating, worse than the 1930’s Great Depression that follow the Smoot Hawley Tariff. As investors consider this situation their reaction could kill the Trump stock rally.
Will the Trump stock rally continue or fizzle? Will the market shrug off rising interest rates or will the Fed’s actions torpedo the stock market? Which are the best stock picks for the coming year and which will be losers? Let us consider how to pick stock winners for 2017. CNBC writes about experts who expect stocks to rise next year.
U.S. stocks should rise slightly in 2017 as equities benefit from tax cuts, according to CNBC’s Market Strategist Survey.
The survey of 13 strategists’ outlooks published since the U.S. election found the median 2017 S&P 500 price target is 2,325, or 3 percent from Friday’s close of 2,258. Credit Suisse only gave a mid-2017 price target of 2,200, while Wells Fargo Investment Institute gave a range of 2,230 to 2,330.
U.S. stocks have soared since President-elect Donald Trump won the election as traders bet on increased growth from Trump’s promises of tax cuts, infrastructure spending and deregulation.
How fast will Trump’s proposals be enacted into law and regulations and when they are in place how well will they work? And are there stocks at risk despite the general optimism? Trump laid into Boeing regarding the new Air Force One being considered for the next decade.
Trump may have been upset when the CEO of Boeing discussed the risk to his company if Trump engages in a trade war with China or he may have been sending a message to the entire defense industry that they will be held accountable to costs. A follow-up phone call from the Boeing CEO resulted in all sorts of positive comments. Never-the-less there may be stocks at risk despite the Trump stock rally. Which stocks are these?
Read the article for our list of major defense stocks that could be at risk even if the market is going up.
The Fed just raised interest rates and we can expect to see more increases in the coming year. What happens to stocks when interest rates go up?
In the early 2000’s interest rates were low and everyone bought more home than they could afford. When rates when up all of those balloons on mortgages came due with higher rates and the housing market collapsed. Today we are seeing a stock bubble based on low interest rates. What will happen to stocks when interest rates go up? The point is that low rates have driven an 8 year bull market in stocks and that is due to come to an end. Will the market calmly slow down or will it collapse?
Banks and utility stocks are interest rate sensitive but in opposite directions. Banks like high rates and utilities suffer. But if rates go up too fast the whole economy is at risk. And as rates go up we could see a reprise of the housing market and stock market collapse of 2008. Warren Buffett is holding onto historic amounts of cash which is what he tends to do when the market is about to tank like it did with the dot com bubble.
In the early 2000’s interest rates were low and everyone bought more home than they could afford. When rates when up all of those balloons on mortgages came due with higher rates and the housing market collapsed. Today we are seeing a stock bubble based on low interest rates. What will happen to stocks when interest rates go up? Forbes interviewed the richest man in the world, Bill Gates. The co-founder of Microsoft says stocks are expensive but what bothers him is that interest rates are so low.
On Tuesday, Microsoft co-founder, Bill Gates, said “stocks are expensive” on CNBC. The bigger issue he raised was interest rates. Mr. Gates is amazed that interest rates have “stayed so low, for so long.” Mr. Gates said, “When do we go back to normal in terms of interest rates [and] multiples, there would be a lot of adjustment there.” Adjustment is a nice way of saying, stocks may sell-off. He also said, “Stocks are higher because of the interest rate environment.” That basically means that valuations have taken a back seat as Central Banks continue to their easy money policies.
The point is that low rates have driven an 8 year bull market in stocks and that is due to come to an end. Will the market calmly slow down or will it collapse?
Increasing Interest Rates
The U.S. Federal Reserve is due to raise rates, perhaps this month. And as economic conditions warrant they will keep raising rates. Many believe that their concern about extinguishing economic growth may be setting us up for a bigger fall when rates do go up. The Wall Street Journal says that the Fed is expected to raise interest rates.
Federal Reserve officials are likely to raise short-term interest rates when their two-day meeting concludes Wednesday, the only increase this year and just the second since June 2006. But what will they signal for the path of rates in 2017 and beyond? This will be the Fed’s first policy meeting since the election of Donald Trump, who has pledged tax cuts and new government spending-policies that could affect the Fed’s outlook for inflation and interest rates over time.
If the policies of the new Trump administration drive inflation higher the Fed will raise rates. The could be quite a bit if Mr. Trump’s version of supply side economics leads to a substantial short term boost.
What Does the Future of Trump and Higher Interest Rates Hold?
Forbes predicts that Trump’s plan will send the U.S. economy into the most severe recession since the 1980’s.
Long-term interest rate will continue to increase. Already, at the 2.5% vicinity it is a blow to a financial system long accustomed and addicted to much lower rates.
A strong and further strengthening dollar has severely unfavorable implications on exports and imports. In dollar terms, the U.S. is the world’s largest exporter reaching $2 trillion. The exposure and vulnerability the U.S. thus has is monumental.
Corporate tax cuts: It is inconceivable that a weakening economy will invest more just because corporations enjoy tax cuts and breaks. It is much more reasonable to assume that the corporate bond bubble of the last few years, used primarily for stock buy-backs and mergers& acquisitions activity, will be used to improve cash flow and debt repayment.
A combination of higher interest rates and poorly thought out economic policy by Trump may well send the market into a nose dive.
Last week President elect Trump criticized Boeing for the two next generation Air Force One presidential jets costing $4 billion. No matter that there is only a contract for design and no contract for building jets to replace the aging Boeing jets that carry the president. Boeing stock fell briefly anyway. Then this week Mr. Trump criticized the F-35 joint strike fighter jet program as having costs out of control. And now Lockheed Martin, United Technologies and BAE systems stocks are trading lower. The Wall Street Journal discusses the effects on defense stocks as Trump targets the F-35 program.
President-elect Donald Trump took aim at one of the Pentagon’s costliest programs on Monday, saying on Twitter the “program and cost” of the F-35 Joint Strike Fighter “is out of control.”
“Billions of dollars can and will be saved on military (and other) purchases after January 20th,” Mr. Trump wrote on Twitter, referring to the day he is sworn in as president.
Just about every defense contractor except Boeing has exposure to the program. Northrop Grumman Corp., a major F-35 supplier, lead an early slide in defense stocks after the president-elect’s latest attack on industry costs. Lockheed Martin and F-35 suppliers United Technologies Corp. and BAE Systems PLC were also lower.
It is not at all certain how Mr. Trump will deal with the cost of advanced military weaponry. However, investors do not like uncertainty and that hurts stock prices. Are defense stocks in trouble or is this just more hype by the President elect prior to assuming the office? Or is this sort of uncertainty going to follow contractors into other arenas?
Selling Jets to Iran
In the aftermath of the Iran nuclear deal Western companies are hoping to do business with Islamic country as it reopens contacts with the West. Boeing has a new $17 billion Iran deal to sell jets.
Boeing Co. clinched a deal to sell 80 jetliners to Iran, completing the first major agreement between a U.S. company and the Islamic Republic, just as the political winds are changing.
Planned aircraft sales by Chicago-based Boeing and European rival Airbus Group SE to Iranian carrier Iran Air are among the most high-profile transactions signed since Iran and Western powers concluded a nuclear accord that removed sanctions on Tehran. U.S. officials cleared the way for Airbus and Boeing to start contract talks in September.
Now, Western executives are trying to figure out whether President-elect Donald Trump will step in to slow, or stop, the tentative approaches many companies have already made.
Considering that Trump has been extremely critical of the Iran nuclear deal, will he cause deals like the purchase of American jets by Iran to fold up and go away? For a man who campaigned on bringing jobs back to America it seems nonsensical that he would muddle up the sale of jets by an American company or any similar deals as contracts between American companies and Iran move forward. However, Mr. Trump has come this far by being unpredictable. That does not bode well for stocks, especially in the defense sector. Read our article about stocks that are at risk despite the Trump stock rally.
Who would have thought that the investment bank that took so much flack during the election campaign would be the all-star of the Trump stock rally? Fortune discusses how this unlikely stock is responsible for sending the Dow into record territory.
Stock market investors who are enjoying the post-election rally-dubbed the “Trump Bump-owe a major debt to the controversial bank that became a political lightning rod in the presidential campaigns.
Goldman Sachs stock is responsible for a whopping 29% of the Dow’s overall bump since the election. Put another way, Goldman Sachs alone is responsible for more than 400 points out of the Dow’s total 1,400-point gain during the “Trump Bump.” Also on Friday, Trump himself offered a White House job to a top Goldman Sachs executive, Gary Cohn, following appointments of two other former Goldman employees to the new administration.
In two recent articles, Is the Stock Market Rally Sustainable and What Stocks Are at Risk despite the Trump Stock Rally, we noted that investors are assuming that infrastructure improvements, offshore corporate cash and tax cuts would lead to more jobs, especially for the middle class. That rationale does not explain the Goldman Sachs rally.
Here is what Fortune says about bank stocks going up.
Bank stocks have benefited from both the anticipation of higher interest rates, which the Federal Reserve is expected to raise next week, as well as the belief that the Trump administration will roll back some of the more onerous financial regulations stemming from the Dodd-Frank Act.
But where does it go from here? Should you be investing in Goldman Sachs and other bank stocks or has the so-called Trump Bump peaked out?
Half and Half
Not everyone is participating in the current stock rally. CNBC Trader Talk says half of Americans are losing out. This largely has to do with the vast exodus from the market after the financial meltdown of 2008.
Everyone knows we lost a vast swath of the investing public after the 2008 financial crisis, and for the most part they have not come back, even as the stock market has come back.
A Gallup poll conducted in April of this year stated that 52 percent of Americans say they invest in stocks, matching a record low, after hitting a record high of 65 percent in 2007.
It’s much worse than this. Stock ownership is increasingly concentrated in the hands of the wealthy. New York University economist Edward Wolff estimated that in 2013 about 90 percent of all stocks were owned by the wealthiest 10 percent of households.
The sad fact is that while Trump campaigned on the promise of improving the life of the average family his election has occasioned another bonanza for the wealthy. Despite bashing the extremely wealthy while pursuing votes Mr. Trump is packing his cabinet with billionaires. Investors should be happy with the Trump Bump and perhaps the market rally will entice more investors to return to the market. Unfortunately continued prosperity depends on the success of Trump’s version of supply side economics and that may or may not work out so well.