Warning Signs Ahead for U.S. Stocks
A famous Greek myth recounts that Daedalus and his son Icarus fled from King Minos and the Island of Crete on wings made of wax. Icarus enjoyed flying and, against his father’s warnings, reached for greater heights. He got too close to the sun and the wings melted. He crashed and drowned in the sea. What does Greek mythology have to do with the markets? You may have already figured out that the Greek myth is a metaphor for the coming economic bust.
This summer you can experience the concept of Icarus in at least two ways. If you have access to “Netflix,” you can watch a documentary about doping in sports called Icarus. The reference again being getting too close to the sun. Or, you can absorb the latest Bank of America Corp (NYSE:BAC) recession warning. Many stocks with “wax wings” (i.e. insufficient earnings) are rising dangerously close to the sun. (Source: “Tick, Tock,” Zero Hedge, July 28, 2017.)
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Bank of America’s chief investment strategist, Michael Hartnett, has been warning investors since the start of 2017 and the Trump rally. Hartnett calls it the “Icarus Effect.” The markets will experience it shortly, leading to the coming economic collapse. The bull’s wings will melt—after all, bulls don’t fly. One of the potential sources of the heat that will melt the market’s wings are the central banks of key economies.
Bank of America Has Identified the Danger
The danger, Bank of America suggests, is that the rally will continue through the summer. This will continue to produce the illusion of earnings growth and U.S. corporate profit. The outcome will only help make the inevitable crash that much harder. The foundations of the incredible—and unconvincing—market rally are weak. Meanwhile, more risks have emerged, adding to the abundant risks that investors should have considered months ago. The question of what the Federal Reserve might or might not do remains.
Inflation has not risen, according to many officials at the Federal Reserve. That has encouraged the Fed to question whether it should raise the nominal interest rate. Doing so would likely slow down the economy and potentially trigger a recession. (Source: “U.S. Inflation Remains Low, and That’s a Problem,” The New York Times, July 24, 2017.)
But it’s a Catch-22 situation; not raising interest rates will only serve to prolong the artificial bull market that fell off the ledge of sanity a few Dow Jones Index records ago. Sooner, rather than later, any number of events—from another Charlottesville, to more “Russiagate” allegations, to whatever black swan event may arise—could trigger a market meltdown. Either way, the markets have risen too high to slow down with any kind of grace, and without making a thumping noise upon landing.
The Fed’s Janet Yellen and other central bankers are now looking for a way out of a labyrinth. Not accidentally, the Daedalus who designed the wax wings also designed the Labyrinth from which he and Icarus escaped. It’s a labyrinth because there’s no convenient way out. Surely, the central bankers can end or slow down the stimulus of zero—or thereabouts—interest rates known as quantitative easing (QE) programs that have characterized these years. But there are no ways to achieve this change without risking U.S. economic collapse.
Thus, those two are the only possibilities. Either the bankers decide to allow the market bubble to inflate and reach closer to the sun, allowing any number of events to expose its weakness and send it down in a furious crash. Or, they accelerate the moment of truth, setting off the sell-off by raising interest rates. Either way, the market blow-up won’t be painless.
Years of low interest rates—almost 10 years—have contributed to confounding investors. In a climate of higher risk, implying more consequences in case of a bad decision, investors chose more carefully. When interest rates are high, you cannot afford to let go of a slow, but secure, compound interest rate for your savings in favor of the volatility of a stock you understand little about. In other words, low interest rates are like fast food. They offer great variety and appear to satisfy hunger, but the long-term risks are serious.
Cheap money has given investors the mistaken luxury of being able to take more risk. The flavor of the month or the season, whether it be Tesla Inc (NASDAQ:TSLA), Amazon.com, Inc. (NASDAQ:AMZN)—all it took to cause a drop was a tweet from President Trump—or Snap Inc (NYSE:SNAP). The point is that near-zero interest has erased the difference between good and bad stocks. That is, investors have little idea of how to identify the truly safe and sound securities.
The low interest rates have also encouraged investors to defy that basic rule of investment: Buy low, sell high. Now it’s buy high all the time. That can only hurt investors’ chances of making a profit, which is the point of investing, is it not? The next crash will be so deep that the resulting financial collapse won’t be able to avoid a recession or economic collapse.
