4 Reasons the Economy Will Crash Within the Year

4 Reasons the Economy Will Crash Within the Year

Stock markets are always a trailing indicator of the health of the economy. They very often remain elevated even after the onset of a recession, only really falling into the depths once the existence of a recession is fully realized. But the behavior of stock markets today is nothing short of amazing.

Many estimates of GDP for the second quarter of this year anticipate a 50% or greater fall in economic output, yet stock markets are still trading at incredibly high levels. Both the Dow Jones Industrial Average and the S&P 500 are trading within about 10% of their all-time highs, and 40% higher than the lows they hit in March. And the Nasdaq hit an all-time high just last week. This is despite the fact that over 40 million Americans lost their jobs over the past few months, economic production has plummeted, and the outlook for the future is incredibly negative. So what gives?

It almost seems as though stock market investors have ceased to care about the possibility of a market crash. They seem to think that things will get back to normal immediately, and that trillions of dollars of Federal Reserve stimulus will paper over any problems that will occur in the meantime. But they’re misguided, and their lack of concern will come back to hurt them. Here are four reasons the economy (and stock markets) will come crashing down within the year.

1. Too Much Monetary Stimulus

The roots of every recession have their beginnings in some form of monetary intervention on the part of central banks and governments. The Great Depression resulted from the Fed’s money creation that fueled the Roaring ‘20s. The stagflation of the 1970s was the result of more Fed money creation during the 1950s and ‘60s. And the Great Recession was caused by the Fed’s loose monetary policy, keeping interest rates too low for too long.

The Fed’s solution to every recession is to create more money, but that just sows the seeds for the next crisis, and the business cycle continues. And every crisis just grows in size and severity in relation to the amount of stimulus used to overcome the previous one.

The monetary response to the 2008 financial crisis was unprecedented and overwhelming, with trillions of dollars of new money being created out of thin air. Despite that monetary tsunami, and interest rates being kept at zero for nearly a decade, the recovery from the 2008 crisis was one of the slowest on record. It was only in the past few years that things sped up, stock markets took off, and it seemed like things were back to normal.

With significant underlying weakness in the economy and cratering stock markets, the Fed earlier this year embarked on a monetary response that made its post-2008 response look minuscule in comparison. Whereas the Fed took years to boost its balance sheet from $800 billion in 2008 to over $4.5 trillion in 2015, it increased the size of its balance sheet this year from $4.3 trillion to nearly $7.2 trillion in just three months. At the expected rate of growth going forward, the Fed’s balance sheet will be at least $8 trillion by the end of the year, if not more.

The Fed doesn’t understand that continually creating money ad infinitum doesn’t solve any problems. It merely delays the full unwinding of previous bubbles, creates new bubbles, and puts off the day of final reckoning. The current bubble being blown is so massive that it could make 2008 look like nothing. We’ve seen some previews of what is to come in February’s stock market selloff, but the real thing will be much worse.

2. Stock Markets Severely Overvalued

The state of stock markets today is much like they were in the heydays of the dotcom boom. Many who remember those days remember how popular day trading had become, and how many day traders quickly moved from stocks to options and futures in an attempt to make even more money. And those who were around back then remember how worthless many stocks became after the dotcom bubble burst. Pets.com anyone?

Today it’s Robinhood and its largely millennial client base piling into stock markets, even to the point of purchasing millions of dollars of stocks from companies that have already declared bankruptcy. People are so invested in the “Fed put” and the idea that these companies are too big to fail that they ignore basic investing fundamentals. There are even anecdotal reports that teenagers and pre-teens are taking advantage of the ease with which they can purchase stocks, helping to boost trades in stocks that are all but guaranteed to lose value.

This type of activity is characteristic of the late stages of a stock market mania. The suckers come out from the woodwork to enter the market, certain that they’ll see gains just as big as those who have been investing for years. But because many of the current gains are the result of professional investors heading for the exits and leaving the suckers to hold the bag, and because there’s only a limited supply of suckers willing to buy the stocks of bankrupt companies, the bubble will come crashing down once reality sets in and no new entrants step up to the plate.

3. Bond Market Weakness

It isn’t just stock markets that have become divorced from economic fundamentals. Bond markets are in a similar situation, and have been for a long time. The corporate debt bubble that existed prior to 2008 only got worse during the decade-long period of near-zero interest rates.

Corporations have issued trillions of dollars of debt over the past decade, much of it of declining quality. Most of that debt was issued not to fund business growth but to buy back shares, thus boosting earnings per share, a key component of executive compensation. But that strategy has saddled companies with trillions of dollars of debt that they now have to pay back. And many of those companies won’t be able to pay off their debts.

We’ve already seen a number of fallen angels, major corporations whose debt has been downgraded to junk status, including Ford, Kraft Heinz, and Macy’s. Many other corporations have either declared bankruptcy or are on the road to declaring bankruptcy. And with the lockdowns that shut down the economy for months, the number of companies not being able to pay their bondholders will only increase as the year goes on.

4. A Long Road to Recovery

Hopes for a V-shaped recovery have been largely dashed by economic data that continues to underwhelm. And with fears of a second wave of the COVID-19 coronavirus, consumers have shown themselves all too willing to shun much of the activity they enjoyed prior to the virus’ emergence. They’re more than happy to keep ordering goods online, avail themselves of takeout and delivery food options, and keep themselves as protected from COVID-19 as they possibly can.

For thousands of brick and mortar businesses, that change in consumer behavior is a death knell for them. Many of them have been burning through cash, and by the end of the year we could see anywhere from 10-50% of small businesses failing.

Millions of Americans will find themselves permanently out of work as a result of all these business failures, and their job prospects won’t be all that great. Remember how long it took for the economy to recover after the 2008 crisis and remember that not only is the economic and employment situation already bad in the US, but we haven’t even seen the worst of it yet.

What we’ve seen so far is a coronavirus-induced recession. When the underlying economic fundamentals that were already going to lead to a recession rear their heads, things will only get worse. And the time it will take the economy to recover will grow even longer.

What Can You Do?

Many investors may see all these signs and understand that their assets are at risk, but they may not know what to do in order to safeguard their retirement savings. They may know that they need to get out of stocks and risky bonds, but what do they do with their money? That’s particularly important for those with tax-advantaged accounts, who may not be able to sell their assets without paying taxes and penalties.

Thankfully there are options out there for everyone. And for those with tax-advantaged retirement accounts such as 401(k), 403(b), TSP, or similar accounts, moving those savings into safer assets is easy to do.

With a gold IRA, investors can roll over existing tax-advantaged retirement savings into a gold investment. That allows them to retain the same tax-advantaged status they’re already enjoying, while simultaneously benefiting from the stability and wealth protection that gold offer.

Gold nearly tripled in price from 2008 to 2011, and there’s no reason it couldn’t do the same over the next few years. With such a severe economic correction on the way, investors need to do everything they can to safeguard their assets and protect them from severe losses. If you’re interested in learning how a gold IRA can protect your retirement investment portfolio, call the experts at Goldco today to find out more.

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