The Dow has been pushed higher by false hope, but its rebound will be short-lived as three big stock market events crush this legless rally.
Remember the first time the Dow crossed 20,000? Well, the blue-chip index could be doomed to re-test this prior psychological support in the next few weeks. | Image: REUTERS/Brendan McDermid
The Dow Jones Industrial Average was modestly higher Wednesday, as all 30 of its components ticked higher after back-to-back losses. Yet again, the optimism was fueled by nothing in particular. Instead, a rally built on overzealous optimism and false hope continued to push the index skyward.
But those waiting on the sidelines for the inevitable stock market crash might not have to wait much longer, as the Dow is probably heading below 20,000 in two weeks.
Perhaps the biggest threat to the stock market’s recent rally is deflation. The Federal Reserve has been adamant that despite its unprecedented intervention, inflation won’t be a problem. But there could be a more significant issue on the cards: deflation.
This week we saw U.S. oil futures dip into negative territory. That could be a microcosm of what’s going on in the broader U.S. economy.
Oil contracts went negative for the first time because the world is running out of places to store it amid declining demand due to coronavirus. While we likely won’t run out of places to store excess inventory or unused services, that won’t stop a lack of demand from weighing on prices.
Enter deflation, one of the main reasons for the Great Depression. A rapid decline in the price of goods and services due to low demand creates a domino effect for the rest of the economy. Lower demand equals lower corporate revenue. Lower corporate income equals more layoffs. More layoffs mean less consumer spending. Rinse and repeat.
Deflation is a horrible signal that no investors want to see, and we won’t know how far inflation fell in April until mid-May. But the Fed considers the Personal Consumption Expenditures Index a key gauge of inflation. In March, it’s expected to show a 0.3% decline when the data set is released on the 30th. Imagine if the drop is steeper.
The Fed’s massive fiscal interjection has kept the market afloat so far, with traders banking on a return to normalcy in the months ahead. Donald Trump’s Reopen America Again plan has been a massive reason for investor optimism. But what if restarting the economy doesn’t offer the sharp recovery the market has been betting on?
Evidence suggests it might not.
For one thing, only consumers can decide when the economy reopens, and preliminary data show they’re not quite ready. Looking at data from China, it’s clear that post-coronavirus consumers are still very cautious.
Chinese consumers continued to spend considerably less on shopping, dining, and outdoor entertainment despite a lack of lockdown restrictions. If Americans follow the same pattern, the economic consequences will be disastrous. Nearly 70% of U.S. GDP is the result of household spending.
The slowdown in consumer spending is assuming the economy is open. There’s a good chance that it will have to be shut down once again if a second wave of coronavirus takes hold of cities that pushed reopening too soon. The University of Washington’s latest coronavirus model shows the death toll increasing 10% amid relaxed social distancing measures.
If inflation data and a failed reopening aren’t enough to dull investors’ enthusiasm about the Dow’s legless rally, a warning from Warren Buffett might. The legendary investor has always advised against selling into a stock market crash—a fact that many have taken as a good reason to buy now.
But it’s important to note that Buffett also believes in exercising caution when the market is greedy, and greed is exactly what this market reflects.
The Fed’s consumer sentiment survey shows where investors see the stock market going. Despite the economic shutdown, investor sentiment actually increased in March. That’s greed, not fear.
Buffett has been stockpiling cash recently, leading many to believe he’d make a big move during this downturn. The fact that he hasn’t speaks volumes.
Of course, we won’t know for sure whether the Oracle of Omaha has started putting his cash to work until Berkshire’s Q1 results on May 1. But the fact that he’s been mostly silent so far suggests he’s not betting on a turnaround just yet.
In any case, if Buffett is still holding on to all that cash—or worse, he’s adding to it—the bulls who’ve been pushing the Dow upward will be severely disappointed.
Disclaimer: The opinions expressed in this article do not necessarily reflect the views of CCN.com and should not be considered investment advice from CCN.com. As of this writing Laura Hoy did not hold a position in any of the aforementioned securities.
Last modified: September 23, 2020 1:50 PM
By using CCN.com you consent to our
privacy & cookie policy.
