Skip to main content

Prognosis Negative: Congress, The Fed, and Geopolitics

The markets continue to defy gravity. Nearly every day they've been reaching new highs. I'm concerned, and have been for a while. There's an awful lot of complacency permeating the market currently. I believe the day of reckoning is approaching, likely before August concludes, but probably no later than mid-September. I think a correction of 10% magnitude wouldn't be surprising, but I'm guessing more like 7-8%. Whatever the actual quantification, there will be an unraveling. Don't freak out - it's long overdue and should provide a nice selective buying opportunity.

There are several factors coming to the fore that I think alone or in combination could be the catalyst for a market decline. Let's examine a few of them briefly.

First, the market has been on a tear without any meaningful pullback. A big early part of that was Trump euphoria. The new administration made bold promises that many believed would help stimulate the economy. Those promises included healthcare reform, tax reform, infrastructure spending, and job creation. The prospects of realizing any of the bold promises wanes further each day. Healthcare reform is in limbo at best, and the dysfunctional business-as-usual attitude of Congress doesn't bode well for progress on the other fronts. Also complicating any hope to accomplish those items is the impending budget approval process and debt ceiling debate. Never put your faith in government.

The latter part of the rally has been earnings-driven, and yes, large cap earnings have been good. But they've been slightly misleading, having been enhanced by a weak dollar. Small cap earnings may be the canary in the coal mine. They've lagged. I think equity valuations in general are overextended.

Second, the Fed intention of further rate hikes could be stymied by lack of inflation. I'm a huge proponent of rate normalization but the Fed missed the boat big-time by waiting as long as they did to start. Either way, there's a potential hiccup somewhere in relation to Fed action. Of more concern might be the plans for the remainder of the massive Fed balance sheet.

Lastly, a geopolitical event is a true wild card. The obvious two are Russia and North Korea. We witnessed a scary escalation of rhetoric on both sides of the North Korea problem earlier today. The market largely took the developments in stride. I don't think it can be ignored for much longer. Often though, it's the geopolitical event you don't see coming to fear most. Remember, we're still at war and an unexpected setback or terrorist attack would be catastrophic.

So that's a lot of Noise, right? Maybe, but the path of least resistance is down. I'm not usually one to prognosticate and avoid trying to time the market, but I have an abundance of caution that I'm not accustomed to harboring. Keep your eye on volatility. It's been unusually low, another warning signal, perhaps.