“May you live in interesting times,” is an ancient Chinese proverb that, while it may seem like a blessing, is often regarded as a curse. Indeed, we find ourselves in such times, where events unfold with startling speed, leaving many struggling to keep pace. For instance, amidst widespread attention on Russia’s actions in Ukraine last week, President Obama presented a staggering $3.9 trillion budget proposal for fiscal year 2015.
This plan includes $56 billion in increased expenditure, requiring tax hikes for the wealthy alongside cuts for those less fortunate. Among other allocations, there’s even $50 million dedicated to preserving bee habitats, which might pique the interest of some readers.
However, we won’t dive into the details of the budget today or discuss the latest developments in Ukraine or the mysterious disappearance of a Malaysia Airlines plane. Rather, we highlight these occurrences to illustrate the plethora of captivating news stories that saturate our daily lives.
Clearly, the public’s attention is stretched thin. Many would prefer to unwind with Jimmy Fallon or dabble with the latest tech gadgets instead of reflecting on diminishing liberties, taxing regulations, and government waste. Yet, there are moments when the deluge of current events compels individuals to take notice.
Unfinished Business
When it comes to the economy, we believe that something intriguing lies just ahead. As winter transitions to spring, it will soon become clear that it is not merely the weather affecting the economy, but rather something far more detrimental.
The sluggish economic recovery is merely a symptom of an underlying weakness within the economy—an issue that no policy adjustment can remedy. A reset of the financial and economic landscape is essential for restoring stability, albeit at the cost of short-term hardships.
In the wake of the 2008 financial crisis, the Federal Reserve and Treasury unleashed trillions of dollars in monetary and fiscal stimulus. While this helped soften the blow, it also obstructed the economy and financial system from regaining structural integrity. The influx of “funny money” prevented necessary corrections from happening, leaving behind a trail of unfinished business.
Instead of facilitating recovery, the stimulus and monetary manipulation distorted the financial system. Although asset prices soared, genuine economic growth remained stagnant. Interest rates were artificially kept low, stocks reached unprecedented heights, and many financial asset prices inflated on the back of printed money, creating a façade of prosperity.
In truth, the economy has been struggling as if it were in poor health—job creation has lagged significantly, and wage growth has stagnated.
Where the Stock Market Must Go
When the stock market experiences its next downturn, it will be painfully evident that a genuine recovery has not occurred. Unfortunately, while the stock market continues to reach new highs, we anticipate a significant correction later this year, with weakening economic indicators likely serving as the harbinger.
The mere tapering of five years of extreme monetary policy will likely unleash turmoil within the stock market. Recall that it was the Federal Reserve’s decision to raise the federal funds rate that led to market declines in both 2000 and 2007—these downturns coincided with economic contraction.
Currently, financial markets are heavily influenced by monetary policies that were unprecedented prior to 2008. Today, we are less concerned with exiting zero interest rate policy (ZIRP) than with the slowdown in the rate of money supply expansion—this alone is creating unease.
Regardless, stocks are bound to decline since they have been on an uninterrupted upward trajectory for the past five years. It is a known truth that eventually, overvalued stocks will become cheaper while undervalued stocks will rise in price.
This principle is as indisputable as the changing seasons. While we cannot predict the exact moment the stock market will turn, the inevitability of that moment is clear.
Will the S&P 500 reach 2,000 before the market experiences a downturn? That’s a question best left to fate. However, should the S&P 500 climb to that level, the subsequent correction is likely to be significant.
Sincerely,
MN Gordon
for Economic Prism
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