The stock market is often described as a roller coaster. But unlike the market, a roller coaster is more fun when it’s going down!
Meanwhile, the past month hasn’t been much fun for investors at all. The Dow Jones Industrial Average has fallen more than 6% from its peak, the NASDAQ is doing even worse, and the markets didn’t recoup any losses today, either.
These gloomy conditions have investors wondering: Are we in store for another bear market? Is an extended swoon, like the one that occurred in 2011, on the horizon? Or could we even be facing a repeat of the market collapse of 2008?
The Fed’s Free Money Tap
The short answer is “probably not.” You see, the market got ahead of itself and is correcting… but it’s not high by historical standards. In fact, the market’s current price-to-earnings ratio (P/E) of 15 is right in line with historical norms and seems downright low in this environment, where money for big players (such as banks) is nearly free.
Additionally, the valuation reflects the widely held view that, at some point, the Federal Reserve is going to have to turn off the free money tap. But paradoxically, corrections such as this one put enormous pressure on the Fed to keep the money flowing.
On the fundamental side, there doesn’t seem to be a near-term threat to corporate earnings. In addition, commodity prices are under control, or even falling. Lower crude prices, which caused the $0.50 decrease in the price of gas since April, have effectively raised nearly $500 for the average American, with more coming during the winter heating season. Elsewhere, manufacturing wages are finally starting to rise in parts of the country, and there are plenty of signs that the consumer is finally getting a break (and can spend a little more freely).
If you’re investing in real companies, these trends in the real economy should provide a value base that can overcome the worries of Eurobonds, hedge fund traders locking in gains, and turmoil in the Middle East. For day traders, those latter trends should add some volatility and maybe further price declines in the near term, but longer-term investors can at least see a short-term bottom.
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So everything is great, yes? Not so fast.
A Storm on the Horizon?
There are a couple of worrying possibilities on the horizon, including those low oil prices that I just mentioned above. While it’s terrific for consumers, taking another $10 off of American crude’s price would suddenly make much of the new oil provided by the fracking revolution uneconomical. That’s a lot of high-paying oilfield workers out of work, a lot of steel pipe manufacturers with shrinking order books, and a lot of rail cars suddenly empty.
Basically, what’s a boom today could be a bust tomorrow.
Another potential problem is home foreclosures. You thought that was behind us, right? Unfortunately, there’s another wave starting now. You see, many states delayed foreclosures through lawsuits and homeowner relief plans. As these programs roll off, we can expect to see a mini-wave of foreclosures.
To be sure, things won’t be as bad as the initial set, but it could be enough to put a cap on home appreciation in many parts of the country – and home appreciation is where most Americans have most of their wealth. Even people unaffected by a foreclosure will be wary of opening their pocketbooks if their homes aren’t appreciating in value. That’s a big deal because, in the end, American consumers are the real driver of most U.S. stocks. The key is for them to have money and spend it.
So for now, don’t panic… but be careful. Use this market decline to buy stocks you wish you had bought before the latest advance. In the meantime, I’ll keep an eye on the two trends above and any other possible threats to the economy.