Following the 2008 housing market crash and subsequent two-year recession, Americans have enjoyed nearly 10 years of continued economic growth. The Obama and early Trump administrations have been characterized by low interest rates, large increases in productivity, and a booming stock market. Despite a recent slide in the Dow Jones Industrial Average, the index still sits 70% higher than it did even at its pre-crash peak and almost three times as high as its ten-year low. Tax cuts by the Trump administration have further emboldened investors, driving estimated real GDP growth to 3% in 2018. That 3% would be the highest rate of expansion not immediately following a depression since 2005.
However, there are reasons that this sustained economic growth may not last. The United States is in the midst of its second-longest recession-free period, and if growth continues throughout 2019 it will eclipse the record-setting era of growth ended by the dot-com bubble.
The chart above indicates seven recessions in the past 50 years, suggesting an average rate of one recession per seven years. Yet this current period of expansion has lasted almost 10 years. Despite the extended cycle, it is not enough to say that the United States is due for a recession without providing other variables to suggest that may indeed be the case.
What’s Causing the Bearish Trends?
The most apparent worrying trend is the recent market downturn and general volatility. The Dow Jones Industrial Average lost 20% of its value in just two months at the end of 2018 before rebounding slightly to enter the new year. The S&P 500 and NASDAQ fared even worse, with both losing around 25% of their value over the same time period before they, too, rebounded slightly.
1. Volatility in US and China Relations
These sharp dips can be explained partially by an imposition of tariffs on Chinese goods and a then-overall pessimism with regards to US-China relations. While the general attitude towards a potential trade deal with China is now more positive, other reasons for the dip remain concerning, and a possible deterioration of talks with China is still possible. On top of a potential trade war, the Chinese government expects their lowest growth since 1990 in 2019, and as consumer confidence waned, overall demand for goods in China dropped by 21.6%. This could have a domino effect, as firms across the world were buoyed by a seemingly ever-expanding Chinese market. Apple, the world’s largest company by market capitalization, has already seen shares fall due to disappointing sales numbers in China.
2. Planned Rate Hikes
One often-cited reason for potential economic slowdown are planned Fed rate hikes. As Federal Funds Rates increase, it becomes more expensive for customers to borrow money from banks. Credit card and mortgage rates rise along with the rate hikes. This has the effect of reducing consumer spending and curbing inflation, overall slowing down the growth of the economy.
The Fed, which kept Funds rates at 0% for seven years in order to curtail recession, had planned to increase the rates in four quarter-point increments in order to safeguard against over-speculation and a repeat of the kind of cheap credit that led to the 2008 crisis. It is perhaps prudent policy, but it reduces the potential for a surging bull market.
Some investors were heartened when Fed Chairman Jerome Powell announced a milder plan of just two quarter-point rate hikes, but the official reasons given in the December 18-19, 2018 Fed minutes include “possibilities of a sharper-than-expected slowdown in global economic growth, a more rapid waning of fiscal stimulus, an escalation in trade tensions, a further tightening of financial conditions, or greater-than-anticipated negative effects from the monetary policy tightening to date.”
3. Rising Political Tension
The Fed minutes cite trade tensions as a possible cause for alarm, and a host of political tensions in general have the potential to affect the economy. An extended government shutdown over the issue of a border wall between the United States and Mexico has impacted the economy, freezing IPOs and, according to a 2014 Congressional Research Service report, reduces GDP growth by 0.1% per week.
4. High Demand for Stocks
Another risk factor in today’s marketplace is the level of household equity share, or the share of total household assets that are invested in the stock market. In a 2016 paper, economist David C. Yang posited that the higher the household equity share, the worse the performance of the market. His data indicated that the metric was more accurate in predicting economic downturn than more commonly used measures such as the cyclically adjusted-price-to-earnings ratio. The basic reasoning behind a high household equity percentage being a portend of a bear market is that if demand for stocks grows too high, then prices also grow too high, and the market is overvalued and in need of a correction.
This graph shows the top performing stock markets came during periods of relative underinvestment such as the 1980s. In addition, the bull market of the 2010s came during 20-year-lows of household equity share. It is then worrying for investors that, according to Ned Davis Research, household equity share is currently higher than at any point since the dot-com bubble in 2001, and well above the historical average. This predictive tool does not necessarily indicate imminent economic collapse, but as household equity share continues to grow, it becomes more and more likely that stocks are overvalued.
5. Increased Interest in Gold
Another signal we may be headed into a bear market is the increased interest in alternatives to stocks. One traditional defensive asset, gold, has a champion in Goldman Sachs. The bank expects that the price of gold will rise 10% in 2019, citing not only recession fears but rising geopolitical tensions incentivizing more central banks to buy safe assets.
The price of the precious metal has already risen by almost 8% since October amidst the volatility of the market. Exchange traded funds, which allow investors to cheaply purchase into a basket of assets, have also soared in popularity in the past three years. One oft-cited reason for this surge in popularity is the hedge against volatility and potential total collapse of an individual stock due to the diversification of assets.
How Investors Combat Market Forces in 2019?
A ten-year bull market has rewarded investors, but it would be an unprecedented run if it were to continue. Rate hikes from the Federal Reserve are looming and could slow down growth. Even if a trade war with China is avoided, the Chinese market is not likely to be as fruitful as it has been in the past. The household equity share indicates a relatively poor return from the market. With a myriad of red flags in traditional stock markets, it’s important to have a solid hedging strategy such alternative investments or fixed income. It is very possible to mitigate the effects of a bear market if investors think outside of the box.