"Goddamn! I didn't think it'd crash that soon! The end of the year?"
The headlines in yesterday's Financial Times were uncompromising and ought to have sent a signal to any sane investor- whether invested in a 401k, or IRA or just ordinary mutual funds, and even stocks. That is, the testimony of Fed Chair Janet Yellen that the economy faces an "uncertain path" under the Donald Trump administration, which will also affect fiscal policy. She also warned against raising interest rates "too slowly" in her appearance before Congress Tuesday.
Is she right? Or is this scare mongering? First, let me remind readers as I've posted about before, Trump's fiscal plans are inherently unstable. The reason is that the plans as they are include virtually NO new revenue and monstrous spending including on increasing the military proportion of the GDP. He also wants an "across the board" tax cut starting with increasing the current standard deduction of $12,600 (for joint filers) now, to $30,000. These deductions, by the way, are what you use when you don't itemize. At the same time, Trump would dump the $ 4, 050 write off claim for each member of a household, e.g. the "personal exemption". He also wants to simplify the tax code by changing from the current seven brackets - ranging from 10 percent to 39.6 % to just three brackets.
In addition, if he gets the help needed from congress, he will scrap in turn: 1) the AMT or alternative minimum tax, 2) the estate tax and 3) the 3.8% surtax on investment income - as part of abolishing Obamacare. As regards the corporate tax rate he would lower it from the current 35 % (actually few businesses pay that rate, most are effectively 5%) and replace it with a 15 percent rate. He has also floated the idea of applying this not only to big corporations but small business owners and the self-employed, including dentists, law partners, and Trump himself.
While all this sounds terrific in theory it carries a steep price tag, which you can get an idea of by studying the graphic below. That is, the national debt as a percentage of GDP would explode through the roof - exceeding the size of the entire U.S. economy within ten years. See e.g.
But long before that staggering event to come, latent fiscal instabilities are bound to play havoc in a stock bubble environment. This includes not only Trump's spending plans but the enormous uncertainty to do with the ACA and its repeal, and what to replace it with. As I posted on December 23rd, the two main hospital lobbies - the American Hospital Association and the Federation of American Hospitals-- have released dovetailing studies that their members will suffer more than $200 billion in potential losses if the health care law is repealed without restoring funding cuts that were used to finance coverage expansion.
In other words, the GOP and Trumpsters are in a real hammerlock. You can't just dismiss $200b in losses to one market sector and not create serious stock market instability. You can't just take away the coverage of 20 million people and not expect political blowback. In the first case, there is the potential for a major correction or crash given the bubble that exists in the DOW and S&P 500.
In addition, and definitely not to be discounted, there is a sobering assessment is from the American Academy of Actuaries. The organization said that delaying the effective date of a repeal while developing a replacement would trigger a crisis for the individual health care market. This is where millions who don't have job-based coverage (including many unemployed Trump voters) can buy policies. This includes more than 10 million with current access to Healthcare.gov.
Factor into this that the current market is way overvalued with P/E ratios through the stratosphere, and you have the earmarks for a crash and even major recession. (This is what actually prompted George Soros for taking a "bear position" after Trump's election for which he is being mocked by the "smartypants" now with the DOW at 20,000 or higher. But what will this lot do when the DOW crashes to 10,000?)
This wasn't merely an abstract exercise for Charlie Farrell, the CEO of Northstar Investment Advisors LLC, writing in The Denver Post Business pages three weeks ago. ('Do You Have The Stomach For The Next Stock Crash?') He wrote:
"For the past eight years, investors have enjoyed a steadily increasing stock market. Memories of the 2008 crisis have largely faded and many investors have forgotten that sinking feeling. But if you want to avoid the mistakes investors made during the last crisis, you should start thinking bad thoughts. Yes., bad thoughts. Start training your brain and your guts for the next stock market decline. Why? Because big stock market crashes and declines happen and they pose a big threat to your wealth."
Does he know something about the Trump agenda others don't. Hardly! Well informed investors would already have processed the Trumpies want to roll back the Dodd-Frank protections that were implemented after the 2008 crash and banking crisis. They'd also know how the fiduciary rule to protect investors has been diluted and some Trumpies want it gutted entirely. As finance columnist Jill Schlesinger put it in her recent column ('Vital Fiduciary Rule Under Fire', D. Post, Feb. 5):
"I thought of the word 'shame' when news emerged that the Republicans in Congress were launching an effort to delay and perhaps kill portions of the Department of Labor's fiduciary rule, which is scheduled to begin implementation on April 10. The potential about face is a slap in the face to anyone who cares about investor protections."
So those two changes alone, to banking regs and the fiduciary rule, could wreak havoc with many. NOw add in the fact the stock market is 250% beyond what it was in late 2009 and you have the makings for real worry. Why? Because a market that has increased 25% or more a year is in dangerous territory.
Arch-forecaster Nate Silver, in his book, The Signal and the Noise- Why So Many Predictions Fail But Some Don’t warns (p. 347):
"Of the eight times in which the S&P 500 has increased at a rate much faster than its historical average over a 5-year period , five cases were followed by a severe and notorious crash, such as the Great Depression and the Black Monday crash of 1987”.
Interestingly, two of the largest stock market dives have followed two of the biggest bubbles: the first of 37.85 percent and on the heels of the bubble that formed from Jan. 14, 2000 to Oct. 9, 2002, and the second of 58.78 percent that formed (mainly due to the housing bubble) from Oct. 9, 2007 to March 9, 2009. People should also be leery of the S&P increasing beyond the range Silver notes over a 5-year period, and the DOW is also a proxy of that. In other words, red alarms ought to have sounded after if it hits 20,000 - and especially if it rises further. Are we in a "bubble"? Check out some of the more current stats using Google and then you decide. But bear in mind when most offerings are over-priced it is likely bubble territory.
All like now, specially with Trump's daffy economic plans in the pipeline (once he settles down, if he ever does) and potential repeal of the ACA, people ought to be re-assessing their risk tolerance. Can you really afford to lose 75 percent of your 401k if the market came a crapper again?
Author Farrell himself is blunt about how you will know if you're ready for stomach churning crash. He asks:
"Do you have the guts to see your stocks decline by 50 percent and stick with them? Most people don't".
He adds that if you are in the market - say with a 401k - and near retirement, you need to have at least three months of cash reserves. Some advisors like Schlesinger say six months is more like it. She also insists those planning on hiring financial advisors need to grill them thoroughly about the investments being proposed and especially how they are being paid. If it is via commissions on sales, they may not have your best interests at heart.
See also:
http://smirkingchimp.com/thread/chuck-collins/71355/wall-street-hopes-you-ve-forgotten-the-crash-already
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