An Assessment
Pursuant to my previous messages, the US economy continues to perform very well. Growth remains strong. Unemployment remains low and is decreasing. We have tons of new investment in the AI arena and strong consumption. The S&P 500 reached another all-time high yesterday. I find it hard to complain.
Except..., inflation remains higher than we would like. We want 2% inflation, and we have 3%. That may not sound so bad, but compounded over years, it makes a difference. Partially, the inflation results from a temporary spike in oil prices. However, growth and wage pressures also contribute. The Fed is correct to raise rates.
So far, the Federal Reserve has raised rates slightly, but treasury bond and mortgage rates have shot up. Real rates for bonds have reached their highest level since the very early 2000s. Homes have become less affordable, as has business financing in all forms.
The best-performing sector consists of already sky-high technology names. The Dow Jones Industrial Average, which has only 30 stocks and a far lower concentration in technology, has fallen by 5% since August, while the tech-heavy S&P and Nasdaq climb higher. If you ask me whether an investment bubble has developed, driven by excitement over AI, similar to the dot com bubble in 2000, I must answer yes, I think so.
When I consider all of these things, I see the possibility of lower oil prices by next year, leading to lower general inflation, lower rates, and a potentially strong stock market rally. Lower rates and optimism about the future always go together. The market will rally on the slightest whiff of such an outcome, long before we perceive it or read about it in the news.
However, in the meantime, with rates heading up and the stock market already at great heights, I also see a risk of a crash. Long time readers know that I don't say this very often. The conditions remind me of those in October of 1987, at the start of my career, when the stock market crashed by 20% in a day. Then as now, we had an expensive market, tension regarding trade, rising bond rates, and a new, inexperienced Fed chairman. At the time, we did not have a hot war in progress, so in some ways, the situation now looks a little more fraught than it did then.
But so what? The Crash of 1987 seemed bad at the time. I remember reading headlines which compared it to 1929 and spoke of another Great Depression. But it was over in a year. Today, we don't remember it and I can't find it on a chart.
More to the point, it took place at the dawn of the finest moment to invest in stock market history. One year earlier, Microsoft, Oracle, and Adobe all went public. No one knew these names at the time. Apple already existed in the public consciousness, but barely. We were, in fact, on the cusp of an extraordinary IT revolution that changed everything and created incredible opportunity for investors.
How have these conditions changed? They haven't! We remain at the edge of a beautiful era of innovation: one infused with driverless cars and rocket ships to Mars and I don't know what else, which will likely move even faster. We should stay invested, not try to time a crash that may or may not take place, remain confident that things will get better and that our stock market will continue to produce the extraordinary returns it has churned out over these many years.
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