THE FEAR FACTOR: FINANCIAL BATTLEFIELDS © Leo Haviland January 5, 2021
“But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions such as they have in Japan over the past decade?” Alan Greenspan, Chairman of the United States Federal Reserve Board, Speech to the American Enterprise Institute for Public Policy Research, “The Challenge of Central Banking in a Democratic Society” (12/5/96)
Voltaire’s 18th century novel, “Candide, or Optimism”, depicts a character who believes that all is for the best in the allegedly best of all possible worlds.
OVERVIEW AND CONCLUSION
In recent times, prices in the S+P 500 and other benchmark United States and global stock indices, lower-grade interest rate instruments within corporate fields (and low-quality foreign dollar-denominated sovereign debt), and commodities “in general” often have risen (or fallen) at roughly the same time. They generally have climbed in significant bull ascents (and fallen in noteworthy bear retreats) “together”. These entangled domains therefore have alternatively reflected joyous bullish enthusiasm as “investors” and other traders avidly hunted for adequate return (“yield”), and terrifying bearish scenes as they raced fearfully for safety. Whether the existing bull trend for American stocks in general (use the S+P 500 as a benchmark) persists is especially important for realms connected with the S+P 500.
Actions by and rhetoric from the Federal Reserve Board and its central banking allies around the globe since the calamitous price crashes during first quarter 2020 restored investor (buying) confidence and generated price rallies in the S+P 500 and related marketplace playgrounds. In response to the economic (and political) challenges of the ravaging coronavirus era, gargantuan deficit spending by the United States and its foreign comrades also assisted these bullish price moves. Based on this as well as past experience (especially in regard to the merciful Fed), marketplace captains and their troops dealing in the S+P 500 and intertwined provinces once again have great faith that these marketplaces will not fall “too far”, or for “very long”. Bullish financial media fight especially hard to promote, justify, and sustain stock marketplace investment and price rallies in particular. In regard to equities in particular, propaganda speaking of “buy and hold for the long run” and “buy the dip” inspired entrenched investors and often sparked new buying. Thus, and despite occasional worries, significant complacency gradually has developed over the past several months in assorted stock marketplaces and “asset classes” tied to them.
Complacency regarding US Treasury yield trends has bolstered the relative calm and bullish optimism in the S+P 500. Strenuous yield repression (and money printing/quantitative easing) by the Federal Reserve Board and its central bank teammates not only assisted the S+P 500 rally, but also boosted belief that US Treasury yields will not shift much higher (and definitely will not rise “too high”) over the next couple of years.
Moreover, (for many months) easygoing stock bulls have had happy visions of recovering corporate earnings for calendar 2021 and rather robust ones thereafter. Numerous S+P 500 bull advocates do not worry much about or downplay risks of historically “high” valuations. “This time is different”, right? Most of these sunny forecasters generally see possibilities for further significant economic stimulus plans (deficit spending) during the upcoming Biden Administration. Encouraged by the development of coronavirus vaccines, they are optimistic regarding the eventual emergence of a V-shaped recovery, or at least an adequate one.
This relative complacency through end-year 2020 in the S+P 500 and many other Wall Street marketplace territories (as the upward price trends evidence) contrasts with the ongoing economic agitation in the wider (“real”; Main Street) arena. Picture, for example, issues of economic inequality and the sharp divide between the “haves” and “have-nots”. Also, underline in America and elsewhere assorted and widespread political splits and heated wordplay. This rhetoric is not merely in regard to establishment/elites versus an array of left (liberal; progressive; keep in mind accusatory weapons such as the labels “socialist”, “communist”, and “Marxist”) and right wing (conservative; reactionary) populist (or “radical” or “fringe”) movements. In the United States, concepts of “identity politics” link to cultural wars involving assorted factors such as race/ethnicity, sex/gender/sexuality, age, religion, and geographic region/urban/suburban/rural. Diverse patriots brawl over the relative merits of nationalism and globalization, capitalism and socialism, and so forth. Though in stock and other fields bulls and bears always battle to some extent, the relative peace and tranquility in many Wall Street marketplaces contrasts with the turmoil and hostility permeating the wider cultural vista.
The dangers of weaker than forecast corporate earnings and lofty valuations for American stocks “in general” probably are significantly greater than the “consensus” wisdom promulgated by stock marketplace bulls. Figuratively speaking, US stock prices around current levels probably have “built in” a substantial amount of predicted earnings growth for calendar 2021 and 2022. Many corporations and small businesses remain under pressure. Year-end 2020 buying of stocks to have further equities on the books by definition is finished. The relatively slow implementation of the coronavirus vaccine is one consideration weighing on the recovery, corporate earnings, and valuation. It likely will take at least several months to vaccinate a substantial share of the global population, including within the United States and other advance nations. Besides, the coronavirus problem is bad and may be worsening. So its burden on economic output and employment levels probably will continue for the next several months
Moreover, despite the complacency regarding United States Treasury yield levels and trends, using the UST 10 year note as a signpost, UST yields probably have commenced a long run increase. Despite widespread global desires for a sufficiently feeble home currency to promote economic recovery and growth, and the related willingness to engage in competitive depreciation to accomplish this, spring 2020 unveiled the onset of substantial US dollar weakness. Although the US dollar (using the Fed’s “Broad Dollar Index” as the yardstick) has withered about ten percent from its peak, its long run pattern probably will remain down.
As “Games People Play: Financial Arenas” (12/1/20) emphasized, these interest rate and currency considerations also warn of a notable decline in the S+P 500. The probable eventual notable climb in US interest rate yields likely will connect with a weaker US dollar. The Fed and the incoming Democratic Administration (and debtors in general) probably want higher American inflation (including higher wages). Massive and rising US (and global) government debt is an important warning sign in this context. American household debt is huge in arithmetic terms, and this will put pressure on much of the nation if the economic recovery is not robust.
Marketplaces, marketplace relationships, and the relative importance (and interrelations) of their variables obviously can and do change over time. However, cultural history can influence “current” marketplace perceptions and decisions, especially when cultural (economic, political, social) conditions are at least significantly similar. Though numerous phenomena were involved in the stock marketplace crashes of 1929 and 2007-09, both occurred in an era of significant debt and leverage. That debt and leverage situation arguably fits the global situation nowadays as well.
Significant fear likely soon will return to the S+P 500, other stock signposts (including those in emerging marketplaces), US corporate bonds, lower-grade foreign dollar-denominated sovereign debt, and many commodities.
What’s the bottom line for the S+P 500’s future trend? Although it is a difficult call, the S+P 500 probably will start a significant correction, and perhaps even a bear trend, in the near future. A five percent move in the S+P 500 over 3588, the important 9/2/20 interim high at 3588, gives 3767, and it probably will be difficult to breach that level by much on a sustained basis. The S+P 500’s high to date, 1/4/21’s 3770, exceeded the 9/2/20 top by 5.1 percent.
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The Fear Factor- Financial Battlefields (1-5-21)