- The stock market is due for a 10%-15% correction.
- There are more headwinds than tailwinds for equities.
- Investors have become overly optimistic about the economy.
The U.S. stock market is nearing all-time highs just as autumn descends on the northern hemisphere, bringing the inevitability of a second wave of coronavirus outbreaks.
It’s a scenario almost identical to that in February–only this time there’s an election on the horizon, and the Federal Reserve has all but exhausted its options. Julian Emanuel, a strategist from BTIG, believes investors should worry—but perhaps not as much as you might think.
Emanuel says a stock market correction between 10% and 15% is likely, pointing to “very vigorous public participation” as undeniable evidence of irrational exuberance among investors. The writing has been on the wall for some time—bankruptcy stocks jumping ever higher, the impossible rise of mega-cap tech companies, and the rush of young, inexperienced investors into platforms like Robinhood.
Emanuel, like many other seasoned investors, says the market has become impossibly detached from the economic reality facing the country. While the Fed’s bazooka of money might be enough to keep the bull market chugging along, a stock market correction looks like a distinct possibility over the next few weeks.
Stock Market Correction as Income Slides
Perhaps the most significant catalyst that will kick off a market correction is the income cliff Americans are slowly marching over. U.S. banks have already set aside $76 billion to cover bad debts as a wave of defaults approaches. Some are estimating that globally, banks will endure losses of $880 billion by the end of 2022.
To put that into perspective, that’s more than four times the loan-loss provisions reported during the financial crisis.
Perhaps we won’t have total failure as we did in 2008, but it would be remiss to expect no consequences to materialize as lost jobs, lower incomes, and fewer hours worked start to hit the economy.
What about Trump’s executive orders? Well, they’re better than nothing, but that’s not saying much. The Peterson Institute for International Economics believes households will see direct aid fall by $500 billion even with the President’s actions:
We estimate the impact would be a deeper recession, a loss of GDP of 4%-5%, and an associated 4%-5% increase in the unemployment rate
Election Won’t Help Stocks
Then there’s the matter of the U.S. presidential election, which is shaping up to be a disaster no matter who wins.
The coronavirus crisis has highlighted the deep political divide in the U.S. The political head-butting will likely get worse if the second wave of outbreaks descends.
If Joe Biden wins the election, it could be disastrous for the stock market as he has vowed to roll back some of Donald Trump’s tax reforms. According to SMH Group CEO George Ball, Biden’s plans for corporate America would bring stock prices 25% lower.
A Trump win doesn’t guarantee market success either. Trump has been under fire for his handling of the coronavirus crisis, his treatment of Black Lives Matters protestors, and his alleged attempts to rig the election in his favor. If he wins, civil unrest is almost guaranteed and could be equally as detrimental to the stock market.
Trade Tension Bad for the Stock Market
If there’s one thing both Trump and Biden agree on, it’s taking a hardline against China.
Washington and Beijing are engaged in a cold war of sorts that will likely continue no matter who is elected. That’s bad for the stock market overall—but it’s particularly bad for the tech sector.
Technology firms, especially huge ones like Apple, depend heavily on integration with China to continue delivering growth.
Investors have largely dismissed the rising tension between the U.S. and China, but that doesn’t make it any less threatening. According to Senior Director for Government Affairs at the U.S.-China Business Council, the cost of severing ties with China could be much larger than the swings we saw last summer as the trade deal was hammered out.
[The cost] could be orders of magnitude bigger on the economy than [the effect of] the trade war and tariffs.
The Bottom Line
It might be hard to envision the stock market dropping significantly after months of flying in the face of the bears. But the bottom line is that this rally is running out of steam. While we may not see a 30% drop, a correction is likely on the horizon, so keep some powder dry.
Disclaimer: The opinions expressed in this article do not necessarily reflect the views of CCN.com and should not be considered investment or trading advice from CCN.com. The author holds no investment position in the above-mentioned securities.