Even though the stock market fell slightly on Tuesday, the bull market is still strongly intact. As you can see from the graph below, the annualized volatility is the lowest since 1965. That’s remarkable as it means the volatility is lower than every year in the entire tech bubble bull market. The year is almost halfway over, so the volatility can easily spike up. The biggest catalyst for volatility would be something unpredictable or the start of the unwind of the Fed’s balance sheet. The German election looks to be almost a guaranteed victory for Merkel which is bullish for the market. Of course, the Chinese elections aren’t democratic so that is also easily predictable. The rally is so strong even oil hitting a 9-month low hasn’t done much to stunt it. The first 5% correction might occur if oil falls into the $30s, but so far the market has mostly ignored it as the tech stocks power the overall index higher.
As you can see from the chart below, the speculation in stocks has driven this low volatility. It looks at the percentage of liquid assets people have compared to the market cap of the S&P 500 and the Wilshire 5000. The percentage of the Wilshire 5000 is showing the same level seen in 2007 while the level is slightly higher than in 2007 when you look at the S&P 500. This is not a perfect metric because many investors have bought bonds. All the money which has come out of liquid assets hasn’t necessarily gone to stocks. With that caveat in place, it has worked as a great indicator in the past if you recognized in 2007 that the level of speculation seen in the tech bubble was unlikely to repeat itself. If you hold the same belief now, you should be cautious. We’re at the same level of speculation as in late 2014 when the S&P 500’s earnings were peaking.
The chart below also doesn’t look good for the market. As you can see the Bloomberg Consumer Comfort index is at the same level it was at in 2007, but it’s much lower than it was in the early 2000s. The blue line is the Boom-Bust Barometer. It jumps out at you how the indicator is much higher than it was in the early 2000s bubble burst and 2007. It divides commodities by the unemployment claims. The index is at its record high because the jobless claims as a percentage of the population is at a record low and the ratio of real assets to financial assets is showing financial assets have never been more expensive. This change is a byproduct of low inflation and a jobless claims stat which may not be as accurate as it once was.
I also think it’s worth noting that despite the low productivity growth rate, innovation has led to commodity prices falling as more natural gas and oil has been extracted via shale and other commodities have become mechanized such as coal and farm products. Innovation is inherently deflationary as it cuts cost. Innovation leading to lower prices was discussed with Amazon buying Whole Foods. Amazon has been able to lower costs for consumers on many items which is why the consumer has decided it is a big winner. The question is why economists cling to wanting 2% inflation given all the great effects low commodity prices and consumer goods have had on Americans. The point I am making is that although the Boom-Bust indicator is worrisome, I wouldn’t go with the assertion that the current economic bubble is double the size of the tech bubble. The bubble is caused by debt which isn’t properly measured in this metric.
As was shown in the strong jobless claims reports, the labor market remains steady. That explains the chart below. The default rates on auto loans remain low despite the decline in auto sales making it look like the market is about to roll over. This default rate chart is taken from S&P/Experian so it shows different results from other metrics I’ve used. Whether defaults are up slightly or not, the only way for them to start increasing fast is if job losses occur. New auto prices won’t fall the way housing fell during 2008, so people won’t be walking away from their cars like they did from their underwater home mortgages. Used car prices will fall, but that wouldn’t make someone walk away from the loan because car values always fall after you purchase them. Interest rates rising also wouldn’t cause defaults to rise because most of the loans are at a fixed rate.
Just because I have shown how it’s difficult to see default rates rise unless the labor market weakens, doesn’t mean that’s a great sign for the industry. If auto sales are already peaking without an increase in default rates, imagine how bad it will get when delinquencies rise and interest rates rise. Sales were boosted by appealing to subprime borrowers. That practice will be halted which will hurt sales. Weak auto sales will weigh on GDP and on the most overvalued stock in the market, Tesla. Tesla acts as a great barometer for exuberance in the stock market because it’s valuation is unrelated to profits.
Conclusion
The speculation in the market is high. This isn’t a bold claim given the size and age of this bull market. However, I don’t think it’s near it end because the economy is not on the brink of a recession. It’s on the brink of having another mediocre first half with growth less than 2%. The third revision of Q1 GDP comes out on June 29th. Unless there’s an upward revision combined with better economic reports in June than May and April, this will be a disappointing first half considering the amount of optimism there was after the election. Many businesses are holding off decisions until they see the fiscal policy plans. This could weigh on the economy as nothing is imminent. 2018’s GDP growth will be reliant on a major tax cut. In my opinion, tax cuts will determine whether the next recession is in 2018 or 2019.
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