Summer vacation is over. School is back. Football dominates the weekend.
As the month turns and fall approaches, it’s time for a reality check. It’s time to pause and take stock of the situation. It’s time to make a decision.
As for the economy and financial markets, it looks like a long, cold winter ahead. Stocks are near all-time highs. Valuations are historically extreme. Cracks are forming in the very foundations of the economy.
For example, U.S. manufacturing contracted for the fifth straight month in August and the 21st time in the past 22 months, according to data provided Tuesday by the Institute for Supply Management (ISM) as part of its monthly report. Manufacturing PMI report.
Specifically, the August manufacturing PMI came in at 47.2. A PMI reading below 50 indicates a contraction in the manufacturing sector, which accounts for 10.3% of the economy. Machinery, textile mills, chemical products, transportation equipment, electrical equipment, home appliances, and components were among the 12 industries that reported contractions.
Of note is the decline in manufacturing output, with the sub-index for production falling to 44.8, the lowest level since May 2020, the dark days of pandemic lockdown madness. According to the ISM, the level of production execution was low. “It puts additional pressure on profitability.”
However, even though demand was weak, manufacturers had higher input costs, partly due to higher freight prices. This is important because it highlights the outlook that the economy is headed for a recession. Prices rise while the economy is headed for a recession.
significant delay
For workers, stagflation means losing their jobs or working fewer hours, and having to pay more for goods and services. It’s a brutal combination.
Workers who remain employed are forced to work at the expense of a lower standard of living. Those who lose their jobs are thrown into the meat grinder. They are pushed back for a decade or more, and some may never get back on level ground.
Stagflation also makes the Federal Reserve’s long-anticipated rate cuts less beneficial. First, there is a significant lag between when a rate cut begins and when its effects seep into the economy.
If the Fed begins to cut rates after the September 17-18 FOMC meeting, the effects of the adjustment may not be felt until mid-2026. Therefore, we can expect the economy to initially contract while the Fed cuts rates. The stock market is also likely to contract as this happens.
At the same time, consumer price inflation is still above the Fed’s arbitrary 2% target. Cutting rates would risk another significant price increase. If prices rise while the economy is slowing, the Fed would be in big trouble. Then it would have to raise rates to curb inflation, which would put even more stress on the economy.
At the very least, lower interest rates will encourage new price distortions in the economy. Cheaper credit will tempt individuals and businesses to borrow money to spend on things that would otherwise be too expensive. Individuals can take out huge home loans as mortgage rates fall. Businesses with little growth prospects can borrow money to buy back their own stock.
Professional economists will likely misinterpret these new price distortions as signs of economic growth rather than the seeds of tomorrow’s disaster.
High anxiety
The reality that the Federal Reserve’s long-awaited rate cut is not a panacea for the economy is deepening the push and pull of fear and greed in the stock market.
On the fear side, there is the perception that the economy is in recession, which is why the Fed cut rates in the first place. On the greed side, there is the expectation that loosening credit conditions will cause borrowed capital to flood into the stock market, further inflating stock prices. This push and pull creates high anxiety.
As you may recall, on August 5th, the Dow Jones Industrial Average (DJIA) fell more than 1,000 points in a single day. The panic quickly subsided. Your broker told you not to worry. He said you should buy when it goes down.
Then, after bouncing back on Tuesday (September 3) and ending August on a high, the DJIA fell more than 600 points. NVIDIA fell more than 9.5%, shedding $279 billion in market cap.
Such a dramatic price drop is a sign that investors are nervous. Perhaps the bubble is finally bursting. The trigger on August 5 was the Bank of Japan’s rate hike on July 31 and the resulting pressure on the yen carry trade.
This week’s path may have been initiated by a subpoena issued to NVIDIA on Tuesday by the U.S. Department of Justice as part of an antitrust investigation. It’s unclear where this will ultimately lead.
But we believe there is something deeper going on than the antitrust battle. We believe that the market’s optimism about AI stocks has been way ahead of its time over the past two years. The supply of new fools is dwindling. And those who want to sell are having to sell at increasingly lower prices.
Reality Check September 2024
AI may have many promising technological applications to discover. But at these prices, big AI stocks are terrible investments. More and more investors are selling and hunkering down until the end of the year.
Time will tell if the bubble has actually burst. If there is a bullish rebound in the coming weeks, consider it an opportunity to sell the rebound. The opportunity to sell at this price may not be there for years.
When a big bubble bursts, it can take decades for it to reach new highs again.
For example, when the DJIA peaked in September 1929, investors thought a new high was just around the corner. Stocks soared for eight years. However, those who bought in September 1929 did not break even until late 1958, nearly 30 years later.
Likewise, when the Nasdaq peaked in early 2000, during the height of the dot-com bubble, the index had been rising for nine years. Investors thought the Nasdaq was a surefire way to get rich. But after the peak in early 2000, it took over 17 years for the Nasdaq to reach a new all-time high.
What would you do if your stock market investments were underwater for the next five years? The next 10 years? The next 20 years?
Will you endure the prolonged bear market, or will you panic and sell at the bottom, the point of maximum pain, and suffer a huge loss of wealth?
The time to ask this question is now. It may be premature to sell 100% of your stocks tomorrow. It is wise to clear some cash so that you can take advantage of extreme buying opportunities that may arise in the coming years.
The reality is, this September, we are in the waning stages of a massive stock market bubble, and Fed rate cuts won’t make it last.
[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.]
thank you,
MN Gordon
For Economic Prism
Back to Economic Prism in Reality Check September 2024
