Worst Case for The Economy and Markets
Some combination of 1.) persistently high prices, 2.) high interest rates, 3.) hot wars and 4.) the potential for civil unrest could derail the U.S. economy and markets in the coming weeks and months. Market psychology could change on a dime. The severity of the change will be a function of Government intervention. If the Fed stays on the sidelines (no Fed put) and if Fiscal spending remains on the current trajectory as the economy slows, then this market could easily lose 50% or more, especially given the concentration in the largest Tech names. Let’s review the list.
1.) Persistently High Prices
The Fed grew the money supply as measured by M1 by 420% from February 2020 - April 2022 - thereby causing a dramatic increase in prices for goods and services. Those prices are not coming back down.
The name of the game is no longer about price inflation and the rate of change (year-over-year CPI and month-to-month CPI). The name of the game is about absolute price levels. Growing the money supply by 420% essentially devalues the Dollar by 420%. Prices have exploded since Q1 2020 as a result. Exponentially higher prices are why Americans have record household debt. Americans are dipping into credit cards to pay for food and everyday expenses. Higher price levels are why the economy is slowing.
Household debt reached a record $17.5 Trillion in Q4 2023.
2.) High Interest Rates
Could the Fed hold its Fed Funds rate above 4% this year and between 3% and 4% in 2025? Sure. I do not believe that the Fed will do so, but it very well could. While I believe the Fed will likely take rates below 2% by 2025, it is possible that rates could remain much higher. If so, annual interest expense on the Federal debt will increase to above $1 trillion and account for approximately 20% of Federal tax receipts. Servicing the Federal debt may crowd out other fiscal spending, including welfare programs, which would further reduce consumer spend. Higher rates for longer also means that the cost of capital will remain elevated. This will further slow the economy as credit becomes more expensive and as equity values take a hit. The equity markets could drop 50% from current levels.
3.) Hot Wars
There are a number of hot wars that could very well expand.
The Ukraine Russia mess of the past 10 years culminated in the present proxy war which began in 2022 and seems no closer to resolution today. Ukraine is largely a result of former State Department official Victoria Nuland’s failed policies. Nuland was part of the Clinton regime, which still has a claw hold on the State Department and its perma-war policies.
The Houthis (an Iran proxy) are driving up the cost of and slowing shipping on the Red Sea and elsewhere. The Egyptian economy is suffering as a result of the Houthis’ Red Sea disruption, which has dramatically reduced commerce on the Suez Canal. Expect for shipping costs and the cost of oil to increase globally so long as this disruption continues.
Gaza is a war zone with Iran funding its proxies in the region. Why didn’t Israel flood the Gaza tunnels to force Hamas to the surface? Doing so would have been a whole lot less dramatic. What is U.S. policy in the region under the Biden Administration. Why don’t we mind our own business in the region?
China may invade Taiwan any day. What would happen if China gained control of Taiwan and therefore TSMC? Chip prices would go up once China exacted a tariff.
The terror attack that occurred at a Moscow concert hall that killed 150 people could happen here in the U.S. Such an attack does not have to be sophisticated. The U.S. CBP has had 9.4 million encounters since Biden took office. Many of those crossing the border are not indigenous to Latin America. Many come from Iran and China, arrive in Venezuela where they receive VZ passports and subsequently cross the Texas border. Let’s assume that of the 9.4 million, 1% are bad apples. That’s 94,000 people. 4 men created havoc in Moscow. What level of damage could 100,000 do here in the U.S.? People pretend that 9/11 never happened or won’t happen again. I hope so, but the math says otherwise.
Source: HERE
4.) The Potential for Civil Unrest
The risk for civil unrest exists given a divided country and a disappearing middle class.
The guilty parties are U.S. Presidents, Congressional bodies, Federal Reserve Chairs and unelected officials (civilian and military) that have kept the gravy train running in the name of self-interest at the expense of the people.
No Presidential Administration, sitting Congress or Fed Chair of the past 100-plus years has served the people well, perhaps with the exception of the Coolidge Administration. Even President Regan whom I admire was rendered largely ineffective by Tip O’Neal’s Congress. Former Fed Chair, the late Paul Volcker, who was the most grounded Fed Chair of the past 50 years saw CPI increase by 62% on his watch. As I wrote earlier, unnecessarily high prices - the result of money printing- have hollowed out the middle class.
Moral hazard. What happens when there is no money for Government handouts?
FDR expanded Socialist practices in the U.S. with the creation of Social Security - a rob Peter to pay Paul wealth redistribution scheme in which both Peter and Paul lose. Peter loses income to Federal Taxes and Paul only gets a portion of Peter’s income - the portion that remains after Government largesse consumes the bulk of Peter’s taxed income.
LBJ took moral hazard to new levels by replacing meritocracy with racial politics. Obama did the same and leveled-up by introducing the concept of Equality of Outcome. Equality of Opportunity is sacred and holy. I wish every American had Equal Opportunity. The opportunity to perform in a meritocratic society. However, Equality of Outcome is evil. Equality of Outcome is a huge disincentive to those of us who are self-motivated. Equality of Outcome eliminates meritocracy and replaces it with politics. The politics of race, the politics of gender, all of the various permutations of woke politics that plague America today. These foolish social policies will go away when there is no Federal money to subsidize various social programs.
Trump did away with the woke politics but was guilty of creating massive moral hazard with his Socialist money-printing scheme - the CARES Act (which Biden has extended and which continues to pay COVID-related cash benefits today, four years after the fact). The CARES Act printed Trillions of Dollars out of thin air, thereby devaluing money in circulation (M1 grew by 420% under Trump and Biden between February 2020 and April 2022, thereby causing prices for goods and services to explode). Zero Dollars should have been printed. Not a single Dollar. Yet, Trillions of new Dollars were sent to businesses, Federal, state and local governments, and to Americans. This sent a terrible message to Americans. A message that says if the economy gets tough, the Federal Government will bail you out with a check. The Federal Government will bail out businesses, it will bail out Government agencies and it will bail out Americans. But at what cost? Look at prices! Look at how prices for goods and services have increased since 2020!
At some point the Dollar will become worthless as has happened to every fiat currency in history. Before then America will face forced austerity. The United States will be forced to go on a severe spending diet. What will happen when social benefits get cut? What will happen when CARES Act benefits cease? What will happen when unemployment and various income assistance benefits go away? The risk of violence increases dramatically. That’s the risk. The trough will eventually run dry for America’s welfare class. It is just a question of when.
The net effect of the above paragraphs is negative Real GDP and equity markets that could potentially get cut in half.