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The Wealth Bubble Popped in Q1. An Epic Stock Market Crash Will Follow

Last Updated September 23, 2020 1:48 PM
Laura Hoy
Last Updated September 23, 2020 1:48 PM
  • The wealth bubble popped in Q1 and it’s likely to bring on a stock market crash as the economic pain continues.
  • There’s virtually no evidence that a V-shaped recovery is on the horizon, suggesting the decline in economic activity will continue.
  • Markets are full of unfounded optimism right now despite troubling sell signals.

Household wealth in the U.S. had risen to shocking levels in 2019 when compared to the GDP increases over the same period. That created a massive wealth bubble similar to those seen in the lead up to the dot-com crash and the 2008-09 recession.

With the market down roughly 20%, it’s safe to say that bubble has officially popped and with it will come a stock market crash of epic proportions. 

Wealth Bubbles and Stock Market Crashes

Wealth bubble data
The wealth bubble popped on two other occasions — both times a stock market crash followed. | Source: St. Louis Fed 

Niels Jensen, the Chief Investment Officer at Absolute Return Partners, noted that household net worth has climbed far faster than GDP, a trend that’s unsustainable .

As of Q4 2019, household wealth-to-GDP was 545%, far higher than the mean value of 380%. That’s indicative of a bubble on the verge of popping: 

Total wealth in society cannot grow faster than nominal GDP over the long term, and that every country has a well-defined mean value in terms of the wealth-to-GDP ratio. In the U.S., that mean value is 380%. In other words, when the actual wealth-to-GDP ratio deviates too much from 380%, you know that the ratio will mean revert at some point. You just don’t know when.

Except, we do know when the bubble will explode, because it’s happening right now.

household wealth data
Household wealth is correlated with market movements. | Source: St. Louis Fed 

Household wealth took a massive hit in the first quarter as Americans lost their jobs and the stock market crashed. Major drops often correlate with a dip in net worth among American households. In Q4 2018, the Dow suffered a 16% loss, which translated into a roughly 4% drop in net worth among American households. 

Economic Downturn Will Further Decrease Household Wealth

Not only are Americans grappling with a sizable decline in their investments, but they’re coping with job losses as well. Pop goes the wealth bubble.

Just as in the dot-com bubble burst and the 2008 recession, this correction in wealth-versus-GDP is followed by a lasting bear market. 

stock market crash
The two previous wealth bubble explosions were followed by bear markets. | Source: Yahoo Finance

Data regarding household wealth won’t be available until this summer, but it’s fair to deduce that it won’t be promising. If we were to have a V-shaped recovery, as the market appears to be hoping, there could be an argument that the wealth bubble would continue to grow—but that is an unlikely outcome.

Daniel Grosvenor, an analyst at Oxford Economics, noted that the current rally is essentially a bet on a V-shaped recovery .

Investors are bullish about the prospects of U.S. firms now that the Federal Reserve has stepped up with a massive stimulus effort. But that’s no more than a stop-gap if the economy doesn’t snap back in the next few weeks. 

The bullish case for stocks rests on the policy measures being enough to prevent widespread financial distress, with the pandemic peaking shortly to allow a sharp, V-shaped rebound in both gross domestic product and earnings growth

By most accounts, the economy isn’t going to snap back. In fact, many are warning that coronavirus could continue to plague countries around the world for up to two years. 

Infectious disease scientist Peter Collignon told Bloomberg that eradication of coronavirus is “unrealistic.” He sees international travel on hold for at least six months  and social distancing to become a way of life until a vaccine is available. That could take up to two years.

stock market crash, airlines
U.S. industries are likely to grapple with lower demand for months, if not years, to come. | Source: Tom Pennington/Getty Images/AFP

The wealth bubble popped in Q1 and with coronavirus still dragging the global economy into a black hole, investors can only assume things are going to get worse. Equities and the housing market will be hardest hit as consumers make massive spending adjustments to cope with the change.

Don’t get caught in this dead cat bounce, all signs are pointing to the exit as a stock market crash looms. 

Disclaimer: The opinions expressed in this article do not necessarily reflect the views of CCN.com.