Stock Market Forecast, Where Stocks Could Be
What’s the stock market outlook for the next three months? It’s pretty hard to see a stock market crash happening with everything being so bullish. Both the Dow Jones Industrial Average and the S&P 500 are in record territory, investor confidence and bullishness are up, and the CBOE Volatility Index (VIX), better known as the “fear index,” is at its lowest levels since 2008.
Sadly, the geriatric bull market is based on an illusion perpetuated by the Federal Reserve and artificially low interest rates. More recently, investors have been betting their retirement portfolios on President Trump’s economic policies, which, most believe, will be good for corporate America and their bank accounts.
Unfortunately, the long-in-the-tooth bull market, which is already the second longest in history, is going to have to start standing on its own four legs. First, the Fed has started to raise rates, and the fuel that has been propelling stocks higher since 2008 is being extinguished. Second, the Trump bump isn’t really based on anything other than hope. And no one should invest on hope.
Consider, U.S. gross domestic product (GDP) in 2016 was just 1.6%, the lowest reading since 2011. It’s also down from the 2.6% increase in 2015. Moreover, while unemployment is below five percent, underemployment is climbing back up to near 10%. The U.S. continues to make room for a lot of low-paying part-time jobs, and one in seven men between the ages of 25 and 54 is not working. Debt levels are also up and savings are down.
All of this is bad for the U.S. economy. And bad for stocks.
When Americans feel good about the economy, they’re optimistic, consumers spend more, and businesses invest. The opposite is also true.
President Trump’s infrastructure plan, fewer regulations, and tax cuts are expected to stimulate the anemic economy he inherited from President Obama. But if Donald Trump can’t deliver on his promises and the economy fails to grow, stocks could crash.
For now, investors are buying into the euphoria and stocks will continue to climb higher and higher in the first quarter.
Stock Market Outlook, Where Stocks Should Be
The stock market prediction for the second and third quarter is not quite as bullish. If investors start paying attention to valuations, the stock market could crash in the spring or early summer. Why? Investors are complacent and stocks are significantly overvalued.
And history is on the side of a stock market crash.
First, the gap between the CBOE Volatility Index and the S&P 500 Forward P/E ratio is at its widest since July 1998, July 1999, and August 2000. After each of these months, the stock market experienced a significant correction.
Three of the most important stock market valuation ratios also point to stocks being significantly overvalued and poised for a crash.
According to the CAPE P/E ratio, the S&P 500 is overvalued by 80%. The ratio is currently at 28.93; the long-term average is 16. It has only been higher for longer twice, in 1929 and 1999. Today’s reading is just a sliver below the 30 reached before Black Tuesday in 1929. In 1999, it was at an eye-watering 45, or overvalued by 181%. (Source: “ONLINE DATA ROBERT SHILLER,” Yale University, last accessed February 14, 2017.)
The market cap to GDP ratio, also referred to as the “Warren Buffett Indicator,” is considered one of the best single measures of stock market valuations. A reading of 100% suggests U.S. stocks are fairly valued. The higher the ratio is over 100%, the more overvalued stocks are.
The market cap to GDP ratio is currently at 129%. The Warren Buffett indicator has only been higher twice since 1950. It’s a hair below the 129.7% from late 2015. In 1999, it was at 153.6%. It was only at 108% before the stock market crashed in 2008.
Lastly, the Wilshire 5000 to GDP ratio is a market cap weighted index of all actively traded, U.S.-headquartered stocks on the major exchanges. The Wilshire is the largest index by market value in the world. The ratio is at an all-time high of around 140.5. (Source: “Wilshire 5000 Total Market Full Cap Index©/Gross Domestic Product,” Federal Reserve Bank of St. Louis, last accessed February 14, 2017.)
Stocks are significantly overvalued no matter how you look at it, and from these valuations, a major correction or crash could, as Nobel Prize-winning economist Robert Shiller recently said, end up in a rerun of the 1929 stock market crash.
Will President Trump’s Policies Usher in a Stock Market Crash?
Fundamentals and technicals aside, there are a large number of events that could let the air out of stocks and trigger a stock market crash. President Donald Trump has already predicted stocks will crash. In fact, he’s already cashed out. Interestingly, many of the events that could cause a stock market crash could come from President Trump’s own policies.
There were a number of times on the campaign trail that Donald Trump warned that stocks were poised to crash. During the first presidential debate, he said stocks are “in a big, fat, ugly bubble.” In April 2016, Trump said he had no faith in the stock market and it was a terrible time to invest. (Source: “In a revealing interview, Trump predicts a ‘massive recession’ but intends to eliminate the national debt in 8 years,” The Washington Post, April 2, 2016.)
Suffice it to say, if stocks were overvalued in April 2016, they’re a lot more overvalued now. And Donald Trump missed out on the rally. Why? Because he led by example. Two months after saying it was a terrible time to invest, Trump sold off his entire $91.0+ million stock portfolio. (Source: “Trump sold all shares in companies in June, spokesman says,” The Washington Post, December 6, 2016.)
With Trump on the sidelines, Wall Street can no longer call him a hypocrite for complaining about how overvalued stocks are and still profiting from it. Though Wall Street now has to pay even closer attention to the Trump administration and its impact on the stock market.
Today, there are three key Trump policies that could usher in a stock market crash in 2017. The first is a trade war with China (the world’s second-biggest economy) and Mexico. During his first week in the Oval Office, President Trump said, “we are going to be imposing a very major border tax on the product when it comes in, which I think it far.” (Source: “The Disaster That Would Be Trump’s Very Major Border Tax,” Forbes, January 23, 2017.)
This cannot have been a surprise. On the campaign trail, Trump threatened to impose tariffs ranging from 35% to 45% on Chinese imports. His “America First” platform, though well-intentioned, could have serious consequences by cutting into corporate profits, undermining consumer confidence, and impeding U.S. economic growth.
That’s because for every one dollar the U.S. exports to China, it imports more than four dollars. This is precisely the kind of trade imbalance President Trump wants to put a stop to. At the same time, this trade imbalance keeps prices low for American consumers.
If Trump imposes trade barriers with China, it will most certainly retaliate. If Donald Trump imposes a tariff of just 10%, exports to the U.S. could fall by up to 25%. If China retaliates, the U.S. economy could slow by a quarter of a percentage point. (Source: “Donald Trump trade war would hurt US and Chinese economic growth,” The Independent, February 8, 2017.)
Second, President Trump’s tax cuts could also hurt Wall Street and send stocks crashing down. Donald Trump recently announced a “phenomenal” tax plan that will be unveiled in the coming weeks. It will be, according to the White House, the “most ambitious tax reform plan since the Reagan era.” (Source: “Trump vows ‘phenomenal’ tax announcement, offers no details,” Reuters, February 9, 2017.)
Everyone likes tax cuts and having more money in their pocket. But when it comes with increased spending ($1.0-trillion infrastructure plan), that means higher debt. It will have the intended effect of creating jobs, but it will also have the unwanted effect of increasing the national debt.
When Trump became President, he inherited a national debt of over $19.0 trillion, and deficit of $559.0 billion. By 2027, U.S. gross debt is expected to soar from $20.0 trillion to $30.0 trillion and debt held by the public could rise from $15.0 trillion to almost $25.0 trillion. (Source: “The Budget and Economic Outlook: 2017-2027,” Congressional Budget Office, January 24, 2017.)
Tax reforms that are not backed up by economic growth is a short-term fix. Throw in rising interest rates and a trade war with China and Mexico, and investor confidence will plunge, along with earnings, followed by a stock market crash.
Lastly, and it is, I hope, remote, but there is fear that growing geopolitical strife will lead to war. Trump has made no secret that he wants to change America’s nuclear policy, which could lead to destabilization. In April 2016, Trump said he was not ruling out using nuclear weapons against ISIS in Iraq and Syria. (Source: “Trump targets ‘single greatest problem’ in the world,” The Washington Post, April 28, 2016.)
In December 2016, Trump said he was willing to engage in an arms race, and that the U.S. “will outmatch them at every pass and outlast them all.” (Source: “‘Let it be an arms race’: Donald Trump appears to double down on nuclear expansion,” The Guardian, December 24, 2016.)
The odds that President Trump would start a nuclear war are infinitesimal, but other nations with nuclear capabilities could get whipped up and start thumping their chests. In addition to growing concerns about North Korea, Iran has said it would start WWIII and destroy Israel if President Trump backs out of the nuclear deal negotiated by President Obama.
Even an everyday, non-nuclear skirmish between the U.S. and Russia, China, Iran, North Korea, etc. could throw the markets into turmoil.
Why Haven’t Stocks Crashed Yet?
Stocks are at record levels and investor optimism and bullishness might be high right now, but those sentiments are hanging by a thread. If you look at the Dow Jones Industrial Average, you’ll see something interesting that has been playing out: a lot of indecisiveness.
Chart courtesy of StockCharts.com
Look at the trading range. The Dow Jones trades in a tight range for months at a time and then as soon as it’s broken, the markets either soar or plunge. Over the last two years, investors have reacted to the downside more often than not.
Chart courtesy of StockCharts.com
A similar thing is happening on the S&P 500 too. For the last two years, stocks have been mostly trading in a tight range, and either break hard to the downside or upside. Mostly to the downside, save for the last few months with investors increasingly optimistic about a Trump presidency.
Regardless, there is no clear long-term trend right now. And that is what could spook investors in the coming months. Investors are optimistic because fourth-quarter earnings have been decent and they believe President Trump’s policies will be good for corporate America. But remember, U.S. stocks only recently exited the longest earnings recession on record. We’re sort of at the bottom looking up.
If the markets churn out another weak quarter or two, investors will be forced to take a hard look at fundamentals. It’ll be tough, one would think, to justify record valuations that are built on weak fundamentals.
If a crack in investor confidence appears or President Donald Trump’s economic policies fail to generate meaningful economic growth, we could see investors run for the exits and major stock indices like the Dow Jones Industrial Average and S&P 500 come crashing down to lows made in early 2016.
The stock market will continue to climb for the next couple months; the Dow could conceivably hit 21,000 with the S&P 500 closing in on 2450; after that, it’s anyone’s guess. Investor optimism has a short shelf life, and investor patience may start to wear thin this spring, with a stock market crash leading the way.