Financial strategist and market expert, Lance Roberts has recently shared an analysis on the website Real Investment Advice, in which he outlined that the common belief that as long as the Federal Reserve is active there would be nothing investors should worry about may actually not be backed by tangible prospects anymore. In fact, the central bank might soon find itself trapped by its own policies, and ended up providing the two pins that will pop the stock market bubble.
All market crashes, which resulted from the preliminary bubble, have actually occurred as a consequence of other factors unrelated to valuation levels. The primary catalysts have varied from liquidity troubles to political actions, reckless monetary policies, economic recessions, or inflationary spikes. Those determinants were the catalyst, or trigger, that led to the investors’ “reversion in sentiment”, and therefore, the crash. Right now, amongst many other possible drives, there are two key factors that very likely to make markets implode.
The first one is inflation. The Federal Reserve has persistently maintained that its monetary policy is a function of two essential components: full employment and price stability. So, on one hand, the Fed has signaled it is willing to let “inflation” run hot, but on the other hand, the central bank’s biggest fear is to repeat the runaway inflation of the 70s. By contrast, the foundation of the entire current bull market is low rates. If historical patterns can still be used to reflect modern-day trends, it appears that very soon the Federal Reserve will start talking about tapering monetary policy, and hiking interest rates.
Consequently, the second key factor would be higher interest rates. As Roberts highlights, the problem with inflation is that if economists do get their wish for higher prices, such also corresponds historically with higher interest rates. However, every time interest rates have moved up correspondingly with inflation, that never remained the case for long. Although much of the media constantly suggests that interest rates are may surge higher due to economic growth and inflationary pressure, the expert disagrees with that notion. Instead, he sustains that economic growth is “governed” by the level of debt and deficits. And at this point, it isn’t just the heavily leveraged government – it is every single facet of the economy. Debt has exploded in pretty much every sector of the economy throughout the past few years.
“So, how did the Federal Reserve fall into this trap?” one may ask. As people often say, “a crisis happens slowly, then all at once.” Considering interest rates affect “payments,” rising rates are likely to have a negative impact on consumption, housing, and investment, which ultimately halts economic growth. That’s why Roberts argues that “with expectations currently off the charts, literally, it will ultimately be the level of interest rates that triggers some “credit event” that starts the great unwinding. It has happened every time in history.”
So now, the biggest concern for the market going forward is that the current prices are backed by the ambitious idea that the economy will experience a speedy recovery back to pre-recession norms, the health crisis will be swiftly controlled and the widespread distribution of a vaccine would put that chapter behind us. However, considering our real economic prospects, and the emergence of two new virus variants, and the slow speed of vaccination, it’s very unlikely that things will go smoothly, so the Federal Reserve is going to have a huge problem.
Every time excessive bullish optimism takes over the stock market it is eventually met with disappointment. In short, the monumental amounts of liquidity, the strong appetite for speculative risk, and a fear of missing out have all merged to fuel asset bubbles especially in the tech sector, cryptocurrencies, and many other speculative startups in favored market segments. Investors may have created and fuelled the bubble, but policymakers are the ones that will make it all explode. As margin debt keeps spiking and continues to contribute to the speculative frenzy, stock prices will remain trading at record-highs even though our bleak economic outlook won’t sustain all of that optimism. All signs point to a coming market crash and the bursting of the tech bubble. At this stage, there’s no more escape.