This stock market is starting to look like 2008

The market action at the start of earnings season was an eye-opener.  Stocks struggled despite very strong earnings from the financial services sector.  In many ways, this stock market is starting to look like 2008 (we’ll get to that in a minute).

To kick things off, America’s biggest bank JPMorgan knocked the cover off the ball.  It reported earnings of $8.7 billion for last quarter.  That was good for an astounding 35% earnings rise year-on-year and well above analyst expectations.  Despite that, its shares fell 2.7%.  Moreover, every other major bank also took a nose dive.

This is a very bearish signal for the stock market.  Investor expectations are so high that crushing earnings isn’t enough to move shares higher.

Looking ahead, this could be a major problem because earnings expectations are high across the board.  Indeed, analysts expect the earnings for all the S&P 500 to grow by a hefty 17% this quarter.   That means earnings could grow by double digits and still disappoint investors.

That problem is exasperated by the fact that …

The stock market is starting to look like 2008 as volatility soars

The VIX annual average has soared a whopping 60% this year.  To put that in perspective, the only other time this happened was in pre-crash 2008.

Moreover, a precise comparison actually looks even more troubling.  The stock market has fallen by 2% or more 7 trading days so far this year.  That is against only a single day where the market has gained 2% or more.

At this time of year in 2008, the stock market had fallen 2% or more on 9 trading days.  But it had also risen by 2% or more on 5 days.  So markets were slightly more volatile but the price movements were more balanced.

Some pundits might say this time is different because there isn’t a looming debt crisis.  However, back in early 2008, few analysts expected the housing crisis.

Moreover, nobody expected things to snowball into an epic debt crisis that led to the collapse of Lehman Brothers, AIG, and Merrill Lynch.  I should know, I worked at AIG at the time and my boss used to boast about the company’s triple AAA credit rating and strong balance sheet.

The stock market is starting to look like 2008 and …

The next crisis is closer than you think

The US government’s finances are in shambles and are increasingly likely to trigger the next crisis. That’s because the government owes a massive $21.1 trillion to lenders.  That puts the gross debt at 106.2% the size of the economy — which is a dangerously high level.

Moreover, the national debt is set to surge further in the coming years.  Congress and President Trump passed a budget deal that creates a massive $1.15 trillion budget deficit for the next fiscal year – which starts in October 2018.  That’s a staggering $500 billion jump from previous projections by the Congressional Budget Office (CBO).

That’ll drive the budget deficit above 5% of gross domestic product (GDP).  To put that in perspective, this is the worst budget deficit relative to GDP outside periods surrounding wars and recessions.

The US government may have trouble financing its debt going forward because …

The Federal Reserve is about to shred the government’s credit card

The Federal Reserve (Fed) has helped the US government rack up debt over the last decade in two ways.  First, the Fed has printed trillions of dollars and used much of it to buy US Treasuries.  Essentially, directly financing the US government’s wasteful spending.

Second, the Fed lowered the interest rate to zero.  This allowed the government to borrow well beyond its means because it essentially paid no interest on this debt.  That’s precisely why the national debt has more than doubled from $9 trillion in 2008 up to a hefty $21.1 trillion now.

US debt is skyrocketing.

However, the Fed is now changing policy from monetary easing to tightening.  To put it more plainly, the Fed is now set on a path to exacerbate the US government’s broken finances by raising interest rates and dumping its vast holdings of US Treasuries.

The Fed has clearly and consistently declared its plans to raise interest rates at least three times this year.  And that’s the minimum.   Indeed, most economists now expect at least four rate hikes (or about a 1% increase) because of rising inflation.

A 1% increase on $21 trillion of debt adds a staggering $210 billion in interest annually.  So, the US government’s interest expense will drift higher just as the US government issues new debt at higher interest rates.

At the same time, rising interest rates also make it more expensive for consumers and businesses to borrow.  That means they’ll also have less money to spend – hurting economic growth.

But the Federal Reserve isn’t going to stop there.  It is now in the process of retiring the vast pile of money it created to fend off the Financial Crisis.

A little background:  The Fed printed up a staggering $3.59 trillion in numerous rounds of Quantitative Easing to calm markets and stabilize the economy.   That was an unfathomable 413% increase to its original $890 billion balance sheet.   This extraordinary tidal wave of money has lifted the stock market, housing prices and inflated virtually every other asset price under the sun.

Former Chairwoman, Janet Yellen, announced that the Fed would begin retiring the money it printed up to the tune of $10 billion a month starting in October 2017.  It would gradually ramp this up to $50 billion a month by October 2018.

That means the Fed is ramping up to take $600 billion of liquidity out of markets every year.  The plan is that this will continue three to four year and will reduce the Fed’s balance sheet to a fraction of its current size.  However, things may not go to plan as a …

Debt crisis could rock America early next year

Certainly, we’re already seeing early signs of Fed tightening hitting US Treasury prices.  The yield on the 10-year note – which acts inversely to Treasury prices – is up about 53 basis points in the last six months.

That’s a hefty rise and is part of the reason why there is such high volatility in equity markets.  Indeed, this is also similar to how the markets reacted to rising mortgage rates pre-crash 2008.  That’s another way this stock market is starting to look like 2008.

The difference is that US Treasuries are the bedrock of the global financial system.  It’s the basis of the risk-free rate from which all other financial assets, including stocks, are priced off of.  Accordingly, any crack up in the US Treasury market will devastate the economy and the financial markets.

Moreover, the Fed has triggered virtually every US recession in the modern era by raising interest rates.  This time, they’re not only raising rates but also draining liquidity from the markets.  That alone guarantees a stock market correction (or worse) later this year.

See more of our analysis here.

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Al Basoglu

I am a financial services professional with over a decade of experience in various roles. I've lived and worked abroad in 5 different countries while pursuing personal and professional challenges. My interests include markets, history and different cultures. I tend to weave all of my interest into my analysis and articles.