When markets rally despite a broad overhang of negative news and outlook, they are said to be ‘climbing a wall of worry’. Indeed this happens rather frequently, more recently and prominently post the Feb-April 2020 COVID market crash and subsequent 81% rally in NASDAQ, concurrent with lockdowns, dire services- & consumer sentiment, and before any vaccines had been approved up until November. One could carefully say it is the default mode of a rallying market – because if all the news were good, they would already be priced in, and it were time to sell.
The current landscape of U.S. financial markets, specifically the rally starting in early 2023, reveals yet another display of such a climb. I’m not one to say “this time it’s different”, because it never is, and because markets can stay irrational for longer than you can stay solvent (as much as I despise quoting Keynes). However, every party of exuberant proportions must eventually come to an end, and though this might not happen today, this week, month or even the next year, the hangover is likely to be quite hysterical – especially when investors are clamoring to some silver lining that only applies to a selective segment of the market, such as speculation on AI which has so far only been beneficial to the top 25 or so tech constituents of the SP500. Long-term underhyped, short-term overhyped.
As the popular and mainly large- & mega-cap indices hammer on, and markets still show long propositions but increasingly also short setups, we are witnessing a concerning oversight of potential risks by the market in aggregate, particularly with the upcoming November 2024 elections on the horizon. A recent and in reality not-so-news announcement by Fed head honcho Powell regarding imminent interest rate cuts has re-ignited a wave of optimism in the markets (recent bull/bear ratios of financial advisors were higher than even the “meme stock” craze in 2021). However, this enthusiasm may be misplaced, as these rate cuts had been started to be priced in since at least early 2024, and could now rather signal the onset of a recession-discounting market pullback – as they quite often do.
Rising unemployment rates and weak job data are troubling indicators that suggest the labor market is softening, which could lead to a downturn in economic activity. The Fed is still promising a soft landing, though many more trustworthy economists such as Lacy Hunt of Hoisington Investment Management Co., fear that Powell has been wearing his rosy glasses too long. Despite these warning signs, the consensus of market participants, analysts and many economists (usually Keynesian and happy with lush Government spending) remain optimistic and do not foresee a recession in the near future – a perspective that warrants skepticism.
The political uncertainties surrounding the upcoming elections pose significant risks to the stability of the U.S. political system. Neither candidate will improve the titanic debt problem, and long-debunked populist ideas of price controls are being thrown around, which will only lead to more misery.
There is a growing concern that the very foundation of the U.S. Constitutional Republic is at risk, with a perceived erosion of the rule of law and a lack of alignment among lawmakers with constitutional principles. The public is waking up to the fact that a large majority of congressmen and -women are corrupt to the bone and deep in the pockets of corporatism (big ag, big pharma, big tech), with >65% of polled citizens believing that political candidates are only out for their personal interests.
The political climate is increasingly marked by radicalization within the Democratic Party, particularly among its progressive wing, which has been associated with violent protests and a rising dissatisfaction with party leadership. This internal strife, coupled with aggressive rhetoric from the Republican party which is equally infighting as well as heavily lobbied, contributes to a climate of deep polarization in American politics – and the resultant heightened emotions in political discourse have not been witnessed since the Civil War era, underscoring the gravity of the current situation.
Economic indicators suggest a troubling trajectory for the U.S. economy. The unemployment rate has risen from a low of 3.4% in April 2023 to 4.3% in July, triggering the Sahm Rule, which serves as a recession indicator. The Bureau of Labor Statistics (BLS) had to again revise payroll gains downwards by a drastic margin, revealing more precarious labor market conditions than initially reported while reinforcing an air of unreliability surrounding government and BLS data. The current budget deficit for fiscal year 2024 is projected to be the highest ever recorded in peacetime, with public spending making up a lion share of GDP. “An economy dependent on the government sector for growth will not perform well”, told us the latest NFIB small business survey. While markets have largely ignored budget deficits since the 1980s, this trend may not continue indefinitely, and a reckoning appears to be showing on the horizon. The gigantic amount of government spending has on the surface avoided a technical recession in 2022 and going forward (as distinctly foreshadowed by the conference board’s leading economic indicators), but that does not mean that people are happy. Manufacturing is in a slump, consumers are bearish, small businesses have been in contraction since COVID, construction is in decline, etc.
On top, the currently seen weakening of the U.S. dollar, which will only be exacerbated by more future rounds of “quantitative easing” that the Fed is apt to indulge in should a recession materialize, could lead to a shift in investor behavior toward safer assets such as gold and Treasury Bills. Globally, countries are selling USD-denominated debt in fear of future sanctions by the US government, amplifying the current bear market in bonds. Fears of a U.S. debt default are prompting central banks to increase their gold reserves (in stark contrast to their Keynesian tenets), reflecting a broader anxiety about the stability of the U.S. economy.
Add to that rising geo-political tensions (Israel and Iran, the proxy war against Russia), a wider trade war with Chin, and we yield yet another layer of complexity to be added the economic landscape with potentially devastating consequences for global stability.
The wider outcomes of the November elections are likely to be pivotal harbingers for the U.S. economy and political landscape, with Bridgewater’s Ray Dalio ballparking as much as a 35-40% probability of civil war in the next decade or less, and the Heritage foundation assessing the current broader situation as an unfolding of the “second American revolution“. A pivotal moment that the markets are ignoring, which has the potential to derail things quite substantially. I make it a habit of avoiding to be a bear at such times, but the picture is for sure not as rosy as central bankers appear to see it.
Vigilance and preparedness in the face of potential upheaval is warranted, as the interplay of economic and political factors could significantly impact market dynamics in the near future. The long-term outlook for Gold and Bitcoin is very bullish. Try to participate in moves into price discovery after sound price consolidations. For equities – stick with what works, and manage risk tightly. There are still a lot of strong setups specifically in the US and EU biotech and pharma sector, but the current rallies in healthcare, staples, REITs and utilities (the latter two essentially bond substitutes) suggest anything but a risk-on market environment.
Tread with care.
