What Blows Up Must Come Down

What Blows Up Must Come Down by Nancy Ohanian

Reporting for Bloomberg News early Wednesday morning, Adam Haigh and April Ma noted that that U.S, and European futures markets plummeted after Iran the Iraqi bases Tuesday night. "Wednesday’s action paralleled market moves on Friday and Monday. Investors dumped risk assets and flocked to havens Friday after the U.S. killed a top Iranian military leader. Then those moves reversed on Monday, even amid warnings against retaliation." This morning everything settled down before markets opened, although gold prices jumped above $1,600 per ounce and benchmark Brent crude jumped as high as $71.75 per barrel, both very bearish signs for stocks.

Desmond Lachman of the American Enterprise Institute used to be a deputy director in the International Monetary Fund's Policy Development Department and the chief emerging market economic strategist at Salomon Smith Barney. His OpEd in The Hill Tuesday was a warning to the GOP about Trump's stock market gamble. Most of us already know that Trump isn't as smart as he thinks he is. Trump, though, doesn't. He wrote that as the election campaign gets into full swing, Señor Trumpanzee ought to "reflect on a 1929 cautionary tale involving Irving Fisher, the pre-eminent U.S. economist of his time. Maybe then Trump would not keep making the stock market’s performance on his watch a principal economic argument in his reelection bid."

On October 22, 1929, two days before the start of the 1929 stock market crash, Irving Fisher was positively bullish on the U.S. stock market outlook. In his view, the U.S. economy’s fundamentals were strong, the stock market was under-valued and stock prices had reached “what looks like a permanently high plateau.”

Unfortunately for Fisher, by the end of November 1929, U.S. stock prices had declined by 30 percent. As a result, his reputation as an economist was in tatters as the stock market continued its descent over the next three years.

Fast forward to 2020, we have President Trump both telling us how great he has made the U.S. economy and trumpeting the 40 percent increase in stock market prices under his watch. In his mind, these are major achievements that warrant his reelection.

Never mind that at this stage in both Bill Clinton and Barack Obama’s presidencies, stock prices had increased by around 50 percent. Or that economic growth under Trump has been little different than that under Obama and around half the pace under Clinton. Or that Trump’s 2017 unfunded  tax cut has caused the budget deficit to balloon and has put the country’s public debt on an explosive path.

Never mind too that the stock market rise under Trump’s watch has probably had a lot more to do with the Federal Reserve’s ultra-easy monetary policy than with Trump’s economic policies. This is especially the case considering that his trade war has contributed to a synchronized global economic slowdown that casts a dark cloud over global financial markets.

More troubling for Trump’s reelection prospects is the fact that the U.S. stock market bull-run is now old by historical standards. Indeed, it is now in its 11th year, and it has seen around a fourfold increase in stock prices from its March 2009 low. According to Nobel Laureate Robert Shiller, this has taken U.S. equity valuations to very lofty levels that have been experienced only three times in the past one hundred years.

Experience with the end of long U.S. bull market runs should be keeping Trump awake at night. Since the early 1970s we have had three bear markets in which U.S. stock prices have declined by around 50 percent and two bear markets in which they have declined by around 30 percent. One would think that a fall by anything like these amounts before November 2020 would almost certainly put paid to Trump’s reelection bid.

Nobody of course knows when the current long-dated bull market will end. Nor does one know what might be the event that will trigger the end to that run.

But one would need to be excessively Pollyannaish not to recognize that the conditions are in place for a serious bear market. The world is drowning in debt and global credit has been misallocated in a major way. At the same time, dark storm clouds are gathering that could precipitate a large U.S. stock market decline well before the first week of November.

It is not simply that the world economy looks to be in poor shape. Europe is now on the cusp of a recession, the Indian and the Chinese economies are slowing down abruptly, the U.S. manufacturing sector is in a slump, world trade tensions continue to simmer and public unrest characterizes all too many countries.

It is also that a geopolitical event like a further escalation in U.S.-Iranian relations or a Middle Eastern unraveling could trigger a disruption in international oil supply and induce international investors to become very much more risk averse than they are today.

While nobody can know when the U.S. stock market might swoon, there is one thing about which one can be certain. It is that if the end of the bull-run does occur before November 2020, Trump will claim that it had nothing to do with his trade or foreign policies. Rather, he will try to convince us that it had everything to do with Federal Reserve Chairman Jerome Powell’s obstinacy to slash interest rates and to engage in another round of quantitative easing.