“Warning! There be Squalls Ahead*” The Stock Market and the 2024 Election

*Quoted From Pirates of the Caribbean, my favorite (and obviously best) Classic Disney Ride. Also, this is my third current events post in a row. Will return to a more personal post next time.

I believe there’s a significant chance that the stock market will have a sharp and sustained decline between now and the 2024 election. Further, such a decline would be intertwined with and exacerbate an economic recession. If this happens, it will make Biden’s re-election far less likely.

In my career in the investment business, I’ve spent some forty years analyzing companies, so I know my way around financial statements. This does not necessarily make me a good investor. In fact, my longstanding grounding in financial analysis has anchored me to certain historical “rules” of valuation. This grounding has undoubtedly made me more cautious at a cost, since over the last ten years we’ve experienced one of the greatest increases in the U.S. stock market in modern history (about a tripling.)

Whether my “rules” will turn out to be permanent relics or whether they will someday again be accepted wisdom, no one can say for certain. (I think they’re coming back, but I’ve thought that for a while and been wrong.)

There are and will always be doomsayers about the stock market. Some of them predict that a horrendous crash will happen any day now. More credible “doomers” will acknowledge that predicting the direction of the stock market in the short term is a fool’s errand. These more credible doomers study the math of market history over long periods of time and analyze various correlations.  Their math convinces them that when valuations are as high as they are today, stock market returns are destined to be lousy for a decade or so, either with (1) a rollercoaster ride (like Big Thunder Mountain) with a deep dive followed by an eventual climb. or (2) a trip with long, gentle sloping ups and downs (like Peter Pan).

All these rides have this in common: you basically end up in the same place you started. That’s disappointing, but not a disaster unless an investor panics and jumps off the rollercoaster during the descent (always keep your restraint bar securely fastened!)

Note that the most credible of the gloomy soothsayers will acknowledge that given a longer timeframe, twenty years or more, stocks are very rarely a bad, or even a disappointing investment.

That said, the analytical work of the credible “doomers” and “gloomers” makes me think that a severe stock market decline is likely enough between now and the 2024 election that I see it as a major political risk to Joe Biden’s re-election. And I don’t think that possibility has entered the political zeitgeist.

I see a number of factors at play:

1)    The financialization of our economy has never seemed higher. The financial media and many investors seem to conflate the rise of a company’s stock with that company’s success. Apple was lauded when its market capitalization breached three trillion dollars, when what’s really remarkable about Apple is its ability to constantly invent great new products. Similarly, the semiconductor chip designer, NVDIA, was praised for rapidly hitting a trillion dollar market capitalization, when what’s really impressive is its transition from designing chips for computer games to becoming the world leader in chip design for artificial intelligence. This focus on the stock market as a substitute signal for business or economic success seems out of kilter.

2)    The tripling of the stock market over the past decade has made people feel wealthier, and that has led to greater spending, the so-called “wealth effect.” This dynamic is a spiral since the more people spend, the more that adds a tailwind to the economy and the profitability of companies. Obviously, the wealth effect can and would work in reverse.

3)    Another factor for the economy is the disappearance of huge pandemic fiscal spending, which helped individuals, companies, and local governments. I believe that Republicans in Congress will do all they can to restrain or even reduce federal spending, even in response to a stock market decline and a recession.

4)    From an historical point of view, not only are valuations of the stock market high, but the profitability of companies for every dollar of revenue they earn is historically high as well. Part of this is due to increased productivity, but part of it is due to an historically low corporate tax rates and what had been historically miniscule interest rates that companies paid on the money they borrowed.

5)    The biggest development worth highlighting is the abrupt ascent of the benchmark short term interest rate as set by the Federal Reserve. It has gone from zero to 5% in sixteen months and is expected now to peak at around 5.5% and then taper off. The Fed’s purpose in raising rates is to cool down inflation. The risk is that at these higher interest rates, the twin engines of economic growth and stock market health will falter, fail, and fall.

Interest rates are important to valuations in that they set a benchmark for investors to compare to other financial assets, like stocks. The Fed’s benchmark interest rate was effectively at zero for such a long time that it gave credence to the acronym TINA, meaning “There Is No Alternative” to stocks. TINA was the right strategy for such a long time, that, human nature being what it is–––so adaptable to and influenced by recency and habit––– I don’t know if anyone has really adjusted to the changed circumstance. I’m still trying to wrap my head around 5% interest rates.

Jerome Powell, the unelected Chairman of the Federal Reserve may well turn out to be the James Comey of 2024, except with interest rates, not with investigations of emails.

If the Fed raises interest rates too much and crashes the market and the economy, that will be a boon to Republicans. Democrats will call for Powell’s head unless he responds by slashing interest rates to rescue the market.  But if he does, Republicans will claim he’s in the tank for Democrats and giving up on fighting inflation.

I’m interested in hearing the opinions of others. Most investors don’t foresee a crash or even subpar returns, so am I seeing phantoms that don’t exist? And, yes, that’s a reference to The Haunted Mansion.   

Note: If you would like to read a well written, well-researched, pessimistic take on the current stock market, check out hussmanfunds.com

And a great data source for stock market history and analytics is Robert Shiller’s website: http://www.econ.yale.edu/~shiller/data.htm

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