Bull markets expire. Bear markets expire. That’s why they call it a market cycle. This cyclicality is inevitable and unavoidable.

 

When a bull market is nearing its end, we often have a difficult time seeing (let alone believing) it. Likewise, when a bear market ends, this too is hard to identify, as we are often too blinded by fear to even consider taking risks in the market.

Our current bull market is approaching ten years; and our economic expansion is about to become the longest since World War II. As all cycles have shown, this cannot go on forever.

Growth will eventually slow, possibly sooner than later. The bull market will reach an expiration point. And what matters most is neither how nor when it’s going to end, but rather, how respond to it.

 

Optimism is Spreading Everywhere, Reaching Everyone (more or less)

 

According to a Business Roundtable survey, most large-company CEOs are brimming with a confidence that far exceeds any measure that they had surveyed in theri 15 years of existence. The same can be said of CFOs, according to a Deloitte survey.  And according to the National Federation of Independent Business, small business leaders are also highly confident about the state of the economy.

Figuratively speaking, the markets are in a celebratory party mode. And with ample optimism backed by strong earnings, this typically leads to greater business spending and investment.

 

What are the economic numbers really telling us?

 

With outstanding GDP growth and an unemployment rate nearing record lows, there’s every reason to feel confident about the economy.

Yet both GDP and unemployment numbers are lagging indicators. They inform you of the past, but not the future. And looking forward, only the future matters.

In other words, there are fundamental forces at work that will always remain absent from reports on productivity and economic strength. The reports themselves may be cause for celebration. But before the celebration comes to an end, the reports also require a keen awareness of and a sober preparation for the future.

 

It makes you wonder whether our current economic expansion is closer to the beginning or the end.

Here are a few hints signaling the possibility of a closure:

  • the stock market is beginning to stagnate (sort of);
  • long-term interest rates are starting to get pushed up, which doesn’t help asset values; and
  • trade war uncertainties are causing businesses who might be affected to stall and reconsider their prospects which delays investment.

 

These are all signs of a looming recession, one that may happen sooner rather than later.

 

Bear Markets Don’t Start Off With a Bang

 

Historically, bear markets never announce themselves. They sneak up on investors at the heights of euphoria. The markets, in response, often don’t “plunge.” They weaken and begin to round-off, as investors begin exiting the markets.

If you study market history, you will notice that the biggest lunge tends to take place toward the end of the bear market; roughly during the last third of a bear market. But at the onset, markets just drift slowly, but downward.

As Ray Dalio, CEO of the largest hedge fund in the world, Bridgewater Associates, has said, “It is not unusual to see strong economies accompanied by falling stock and other asset prices… we know that we are in the ‘late-cycle.’” And this “late cycle” may be what we are seeing at the present time.

As the current economic expansion reached its 110th month, an astounding duration which we can view as “super-centenarian,” the Congressional Budget Office (CBO) forecasted a continuing rise in interest rates and inflation; a late-cycle characteristic. Note that the average expansion is just 39 months. And although outliving average age doesn’t indicate a coming death, it does raise the possibility of a fundamental weakening; that something in the economy is about to give (what else would bring on the end of a cycle?).

 

Our Economic Output is Threatened by a Lack of Workers

 

For a country to be productive, it needs a productive and growing workforce. In October of last year, the Bureau of Labor and Statistics predicted that 11.5 million jobs will be created between 2016 and 2026. They also predicted that the US will come short of one million workers to fill those jobs. The reason: declining birth rates in the US.

US companies have made up for this workforce deficit by hiring immigrants. In 2017, immigrants made up over 17% of the US workforce.  

But the Trump administration’s current stance on immigration has made it clear to the world that the US may be an immigrant-hostile nation. And with growing demand for immigrant workers in other developed nations, competition for foreign-born talent may be heading elsewhere, which is not necessarily the best thing for the US economy, given the growing shortage of workers.

 

Trade War Effects Can Be Overwhelmingly Negative

 

It is known that purchasing labor and materials abroad has been a strong engine of growth for many American businesses. If a business perceives the cost benefits of buying abroad to be more beneficial than buying domestically–whether that transaction may be completely or only partially “fair”–chances are that the benefits probably outweigh the disadvantages.

The trade war simply weakens this growth engine, as escalating tariffs impose a real cost burden for business who rely on foreign goods. But in addition to this, the uncertainty of where this trade war will lead and its big-picture consequences may undermine investor confidence. Markets don’t like uncertainty, and the trade war’s unknown impact on real fundamentals is far from predictable and therefore far from certain.

 

Corporate Debt is Sky High

To put it quite plainly, nonfinancial corporate debt has increased beyond 73% of our GDP. That’s a record-breaking level. Many businesses claim to be sitting on cash, but what most investors don’t realize is that a large majority of them are also carrying a potentially-crushing debt burden.

Corporate debt levels have risen to such a degree that even the Fed is becoming concerned. As Fed governor Brainard had mentioned: “Our scan of financial vulnerabilities suggests elevated risks in two areas: asset valuations and business leverage.”  A single negative shock to earnings plus increased interest rates can create havoc on the corporate bond market, affecting not only the bonds themselves and their lenders but potentially the US economy as a whole.

 

Might It Be Time to Prepare for the End of the Cycle?

 

Despite the fact that many leading indicators are pointing down, it doesn’t mean that our expansion will end immediately. We may see it continuing through the next few months up until the end of the year. The main point here is to prepare for when it does end.

And remember that all cycles eventually come to an end.

 


 

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