Factors That Can Negatively Influence This "All-Time High Market"
By Professor Pierre Fournier
Many times I have been accused of being a perpetual optimist about the stock market. And why not? How many short sellers do you see on the Fortune 500 list? How many pessimists are among the richest people in the world? Pessimists never make money, at least not permanently.
But in the interest of fairness, and to take our rose-coloured glasses off, let’s take a look at five things that could go horribly wrong in the stock market. I am not saying they will happen — only that they could happen. I will leave out anything related to COVID-19 or vaccines, as that is too obvious and also too unpredictable.
Interest rates may increase
Ten-year rates climbed last two weeks, and are slowly but surely moving higher. At 1.5 percent, no one is too concerned — yet. But we have seen some sharp market declines when rates hit two percent. Investors always freak out about an inverted yield curve. We are nowhere near that yet, but who knows? Rates can move sharply at any time. Many optimistic investors will note that the Fed “intends to keep rates low until 2023, at least”. But we would note that bond prices and yields do not necessarily follow the Fed’s template. Rates can still potentially move higher, despite what the Fed says. When rates rise, the “risky” stock market can become less attractive versus safer bonds, but the main impact is on the discounted valuation of growth stocks — you know, that sector that has been leading the market for years. What happens if these fall out of bed?
Inflation could come-back
If inflation does pop higher than expected that can be nasty for the market. What’s worse, is that inflation can crush “safe” dividend stocks as well. So there are not many places to hide in the market if inflation returns after a decades-long absence. Governments, for the most part, have been far more worried about deflation in recent years. Deflation, in fact, is much worse than inflation, and you do not want to see it take hold. But inflation — especially when not accompanied by growth — can still devastate an investment portfolio if it doesn’t own sectors such as metals and gold.
Bubbles could burst
I always laugh when an investor complains about a stock that is “only” up 20 percent so far this year. But it is that type of market. With cannabis companies and special purpose acquisition companies (SPACs) doubling or tripling in the first two months of 2021, investors are becoming a little too complacent towards giant and quick stock market gains. Valuations don’t matter much anymore. Some companies are trading at 100 times revenue. Electric vehicles, batteries, energy storage, you name it — there are pockets of the market with valuations that even aggressive investors would call extreme. Any such bubble could pop at any time. Now, I am not so sure the “bubble” sectors are big enough to bring down the whole market, but a pop in one or more would certainly cause some short-term market pain.
Bankruptcies could give investors pause
In the January short-covering, Reddit/GameStop (GME on NYSE) frenzy, there were a couple of hedge funds that found themselves in serious trouble, so much so that they needed a bailout. Many stocks declined as those hedge funds sold long assets to meet margin calls. For those old enough to remember, a very large hedge fund, Long Term Capital Management, very nearly brought the entire market down in 1998 when it got into trouble. It is very possible there is a large hedge fund, or two, or three that are out there today that are running into trouble betting on the wrong securities or sectors. There could be danger lurking and we wouldn’t even know it, yet. But a bankruptcy of a hedge fund might not make investors care much. Just more hedge funds “betting” instead of investing. But what about some large corporate bankruptcies? Surely, there are many companies out there that are just hanging by a thread, waiting for the pandemic to end. One or two more problems could see these companies throw in the towel. A large corporate bankruptcy might get investors worried about bank loan losses, which they have so far completely ignored. Remember 2008, when companies were falling by the day?
Earnings growth could be disappointing
Everyone expects better corporate earnings growth this year. The market is counting on it. But what if it doesn’t happen? What if consumers decide they like saving? What if corporations stay cautious and don’t go on shopping sprees for hardware and software? What if cost creep (see inflation above) cuts into profit margins? What if product shortages (i.e. the recent chip shortage) simply mean companies can’t sell what they thought they could, even if demand is there? The market is counting on better earnings. If they don’t materialize, there might be some quick profit-taking and a very weak market outlook.
Disclaimer: This article is intended to be used and must be used for informational purposes only. It is very important to do your own analysis before making an investment based on your own personal circumstances.