Yesterday we discussed what is going on with stocks and one of the explanations is that the market is pricing in the end of the economic cycle. If that is true, there is lots of more downside for stocks. Let’s see what the latest economic news are, how that fits the economic cycle, what is the probability for a recession and what should we expect from stocks.
The economic news is relatively good. Jobless claims have reached the lowest level in history.
The unemployment rate is expected to fall even further which means more jobs and an even stronger economy.
And, inflation is slowly reaching the FED’s target of 2% which shows healthy demand for good and services.
To sum it all up, even the FED has increased their economic growth projections. So, things haven’t been this good in the past 8 years, so why are stocks declining or why are the markets so nervous?
Well, those who have a longer term perspective on things, by longer term I mean a cyclical perspective on things know that the economy, all economies for that matter work in cycles and after 8 years of economic growth, it is a good time for a quick consolidation and recession which is always painful, for stocks, people and especially the business environment. Let’s see where we are in the cycle.
The Economic Cycle
There are three major components of economic growth: productivity, the short term debt cycle and the long term debt cycle. Today I’ll focus on the short term debt cycle first, mention the long term too to show what can happen and we will touch on productivity some other time as the credit is the most important thing now.
So, an economy is driven by credit, the more credit there is the bigger is the growth as consumers spend more. So, let’s take a look at consumer credit.
At some point people will reach their credit maximum
Higher interest rates will increase debt payments and defaults
Demand for cars, trips, pools, houses will drop
A recession is inevitable, the question is only when
What does this mean for stocks?
A short term debt cycle recession would eradicate the weeds from the stock market, readjust valuations on good business and offer plenty of buying opportunities.
If the long term debt cycle bursts we are in for a complete change of how things work and how things have worked over the past 75 years. Instead of constant debt growth what has been going on over the last 75 years, we would be seeing painful deleveraging, probably inflation as governments would rush to print even more money and stagflation. One chart will explain what I mean.