Stock Market And Economy – Disheartening ‘W’ Pattern Is Forming

The stock market was in a happy “V” pattern, as Wall Street gained confidence that an economy “V” pattern was coming. Sure enough, employment, consumer spending and growth forecasts began improving, aided by the various government stimulus programs.

Then, as the stock market continued to rise with technology stocks outperforming, the shift from index fund investing to speculative stock buying began. However, as with most stock market’s popular trends, this one became stretched and is now in a reversal period. The question is: Where will stocks go from here?

Disclosure: Author is 100% invested in cash reserves

Bubble? Then expect more burst to happen

This weekend’s Barron’s cover article is well-timed: “Yes, It’s a Stock Market Bubble. That Doesn’t Mean Trouble for Investors Just Yet.” The write-up describes the rationale behind the market rise, and technology stocks’ outperformance.

However, the article’s conclusion that the bubble doesn’t have to burst yet presumes that the rationale is still effective. Unfortunately, though, strong uptrends that are based on seemingly powerful and long-lasting fundamentals can peter out “unexpectedly.” Therefore, instead of accepting Barron’s conclusion, view it as a contrarian sign that it is the selloff that is not yet over.

But there is more to this selloff than seeking a return to normality for tech stocks. There also is a growing concern that company and economy fundamentals are about to lose some of their recent shine. Here is how that view is shaping up…

To begin with, remember why stocks rose in the first place

It was the anticipated economy improvements. Well, those have happened. So, the question now is not whether tech stocks will resume their uptrends from this correction. It’s whether the economy improvements can continue and the conditions will still favor tech stocks.

Now to the problems…

Problem #1 – Employment improvements are slowing, even as unemployment remains high

Time marches on (it’s now six months after the mid-March shutdowns), but the unemployment level remains much higher than during the Great Recession. Moreover, as we have been reading, new hiring is slowing down.

Then, there is this unemployment dynamic: Barron’s – “Temporary Layoffs Are Starting to Look Permanent. That’s Bad for the Recovery.”

Problem #2 – The once anticipated second stimulus program looks like a non-starter

Early expectations were for another $trillion or two flowing to unemployed and underemployed consumers, struggling and still-closed organizations, and local and state governments. Now little is expected, meaning the economy will have no “growth boost.” That absence raises the specter of a stagnant or weakened economy. In turn, if such a development does occur, we can expect the March/April fear of an extended recession to return.

Problem #3 – The somewhat fragile financial system

Without stimulus and with reduced economy improvement, the time limits on financial deferments (credit cards, loans and mortgages) will begin to expire and cause problems. Ditto for the temporary halts on renter evictions and homeowner foreclosures.

Besides the bad effects on adversely affected debtors, lenders will need to revisit their worst-case models. That could mean the need to expense more bad debt reserves. (This action would be the reverse of what some analysts were hoping for – less bad debt than expected producing added income as lenders reversed excess reserves.)

Then, there are the other areas that are already feeling ill effects: municipal bonds, lower credit bonds, emerging market bonds, etc.

But what about the new, high levels of auto/truck and new housing purchases?

There are two drivers at work with these:

First pent-up demand – The combination of normal and delayed purchases from those earlier, weak months

Low interest rate incentives – The Federal Reserve’s near-zero interest rate setting allows auto/truck manufacturers and home builders to maintain profitability (prices) while consumers feel they are getting a deal – if they act now

Likely, neither driver will be long-lasting, particularly if employment worries kick up again.

The bottom line – The tech bubble likely will not re-inflate

There has been clear “improvement” in the economy since nonessential closedowns occurred in March. However, most of this improvement came from simply reopening (in one form or another) with the positive impact from the stimulus payments.

Therefore, even as reopening broadens, added costs and restricted revenues will prevent a return to pre-coronavirus income levels. Moreover, with government benefits petering out and hiring slowing down, expectations of growth should be tempered.

All the above means that technology stocks and the stock market in general are likely to continue their downward adjustment period (i.e., extending the second downtrend in a “W” pattern).

The good news is that we then get to look forward to that second “W” uptrend.

This is my fifth article discussing this selloff. Here are my previous four articles…

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