Summer break is over. School is back in session. Football rules the weekend.
With the turn of the month, and the approaching autumn season, comes a reality check. A time to pause and take stock of where things stand. A time to make decisions.
With respect to the economy and financial markets, there appears to be a long, cold winter ahead. Stocks are near their all-time highs. Valuations are at historic extremes. While cracks are appearing in the economy’s foundation.
For example, U.S. manufacturing contracted in August for the fifth consecutive month and the 21st time in the last 22 months. These were the findings offered by the Institute for Supply Management (ISM) on Tuesday as part of its monthly Manufacturing PMI report.
Specifically, the manufacturing PMI for August came in at 47.2. A PMI reading below 50 indicates contraction in the manufacturing sector, which accounts for 10.3 percent of the economy. Machinery, textile mills, chemical products, transportation equipment, electrical equipment, and appliances and components were among the 12 industries reporting contraction.
Of note was the decline in manufacturing output, with the production sub-index slipping to 44.8. This marked its lowest level since May 2020, during the dark days of pandemic lockdown madness. According to the ISM, the low level of production execution was “putting additional pressure on profitability.”
Yet even with weak demand, manufacturers experienced higher costs for inputs. This was caused, in part, by rising freight prices. This is important because it highlights the prospect the economy is facing an episode of stagflation, where prices rise while the economy contracts.
Significant Lag
Stagflation, for workers, means losing their jobs or getting their hours cut, while having to pay more for goods and services. This is a brutal combination.
Workers who remain employed must labor in return for a declining standard of living. Those who lose their jobs are run through the meatgrinder. They are setback a decade or more; some may never get back to level footing.
Stagflation also makes the long-anticipated rate cuts from the Federal Reserve less beneficial. First, there is a significant lag from when rate cuts are initiated to when their effects filter through the economy.
If the Fed begins cutting rates following the September 17 and 18 FOMC meeting, the accommodative effect may not be felt until mid-2026. So, you can expect the economy to initially contract while Fed rate cuts are taking place. The stock market will also likely contract as this happens.
At the same time, consumer price inflation is still above the Fed’s arbitrary 2 percent target. Rate cuts will come at the risk of another bout of significant price increases. If prices rise while the economy slumps the Fed is in big trouble. It will then be forced to hike interest rates to contain inflation, which will further stress the economy.
At a minimum, rate cuts will propel new price distortions within the economy. The cheapening of credit will entice individuals and businesses to borrow money and spend it on things that would otherwise be too expensive. Individuals may see a dip in mortgage rates and take on a mega home loan. Businesses with little growth prospects may borrow money to buy back their own shares.
Professional economists will mistake these new price distortions as signs of economic growth, rather than the seeds of tomorrow’s disaster.
High Anxiety
The reality that the Fed’s much anticipated rate cuts are not a magic answer for what’s ailing the economy is now intensifying the push and pull of fear and greed within the stock market.
On the fear side is the recognition that the economy is slumping, and this is why the Fed is cutting interest rates to begin with. On the greed side is the anticipation that easing credit conditions will drive borrowed capital into the stock market and further inflate share prices. This push and pull is creating high anxiety.
If you recall, on August 5 the Dow Jones Industrial Average (DJIA) dropped over 1,000 points in a single day. The panic quickly subsided. Your broker said it was nothing to worry about; that you should buy the dip.
Then, on Tuesday (September 3), after rebounding and closing out the month of August for a gain, the DJIA fell over 600 points. NVIDIA fell over 9.5 percent – for a $279 billion loss in market capitalization.
These dramatic price plunges are an indication that investors are uneasy. Perhaps the bubble may finally be popping. The trigger for August 5 was a hike in interest rates by the Bank of Japan on July 31, and the resulting pressure on the yen carry trade.
This week’s route may have been triggered by the subpoena issued to NVIDIA on Tuesday by the U.S. Justice Department as part of its antitrust investigation. Where this will ultimately lead is unclear.
But we believe something deeper is going on than an antitrust fight. We believe market optimism for AI stocks got well ahead of itself over the last two years. The supply of new suckers is running thin. And those looking to sell are having to do so at lower and lower prices.
Reality Check September 2024
AI may have many promising technological applications that will be discovered. However, at these prices, the big AI stocks make terrible investments. It appears that more and more investors are looking to sell out and hunker down through the end of the year.
Time will tell if, in fact, the bubble has popped. If the bulls mount a rebound over the next few weeks, consider this an opportunity to sell the bounce. You may not get another chance to sell at these prices for many years to come.
When big bubbles deflate it can take decades to get back to new highs.
For example, when the DJIA peaked out in September 1929, investors thought new highs were just around the corner. Stocks had gone straight up for eight years. Yet, those who bought in September 1929 didn’t break even until late-1958 – nearly 30 years later.
Similarly, when the NASDAQ peaked in early-2000, at the height of the dot com bubble, the index had gone up for nine years. Investors thought the NASDAQ was a surefire path to riches. But after the peak in early-2000, it took over 17 years for the NASDAQ to hit a new all-time high.
What would you do if your stock market investments were underwater for the next 5 years? What about the next 10 years? Or the next 20 years?
Would you hold through the extended bear market? Or would you panic and sell out at the bottom, at the point of maximum pain, and lock in a catastrophic loss of wealth?
The time to ask these questions is now. Selling 100 percent of your stocks tomorrow may be rash. Freeing up some cash so you can take advantage of the extreme buy opportunities that will become available over the next several years is shrewd.
The reality, this September, is that we’re in the waning days of a mega stock market bubble. And Fed rate cuts won’t sustain it.
[Editor’s note: It really is amazing how just a few simple contrary decisions can lead to life-changing wealth. And right now, at this very moment, I’m preparing to make a contrary decision once again. >> And I’d like to show you how you can too.]
Sincerely,
MN Gordon
for Economic Prism
