The next bubble is about to burst. No, it's not the housing bubble, though it's directly related to it. In my opinion, it's the consumer confidence bubble. And it will start as early as this coming fall or summer.
Personal savings has maintained a persistent streak in the negative, which boggles my mind. I thought that Congress was the only group of people so broadly and reliably irresponsible with money. Apparently though people have been borrowing against the equity on their house, or indirectly using their growth in house equity to offset debts accumulated in other areas or to justify spending money instead of saving for retirement.
Given that consumers power 2/3 of the American economy, there are several indicators that the stock market will feel the pinch from declined consumerism:
- As housing valuations stagnate and speculators dump unwanted properties on the market, homes will become increasingly difficult to sell at the price that people feel they are entitled to. A feedback loop will fuel this downward spiral, though perhaps not as dramatically as the tech burst.
- However consumers are already showing signs of lacking confidence in the economy. Producer prices are still high, driving inflation and causing increasing interest rate hikes from the Fed.
- Demand for Gold is up, often an indicator of cautious investors hedging against inflation.
- And despite inflation, we are seeing very little improvement in wages or job growth, leading to a situation known as stagflation: stagnation in growth with broadly increasing prices. This has a profound impact on consumerism. And the biggest contributor to rising prices is the cost of oil, which will only get worse during the busy summer travel season, setting us up for a major pinch if this coming winter is less mild than the last.
- Increasing interest rates usually cause yields on all bonds to rise due to a better rate of return, however we have seen the yields on short-term bonds rising faster than long-term, causing the yield curve to flatten. [Edit:] Since prices on bonds move in the opposite direction as the yields produced, it's important to note that curve has flattened due to high demand for long-term bonds, leading to lower yields on those bonds. (Thanks to reader Detroit Dan for that clarification!)
- Demand for long-term bonds has been high due to the high interest rates, but once the Fed is done raising interest rates and demand spikes for long-term bonds, the yield will drop further and an inverted yield curve could occur, a frequent indicator of an impending recession caused by widespread pessimism in the health of the economy.
- Given that the PPI is still high (and increasing with the cost of oil), the only thing that may cause the Fed to stop raising interest rates is a weakened economy, where stagnation is worse than inflation and the Fed can only attempt to fix one. This again reinforces my belief that the yield curve will invert, and that a recession will occur due to widespread pessimism.
- Carrying this trend further, increasing interest rates are going to hammer home owners that have ARMs. Combined with the inability to sell houses, consumers are going to have to start watching their spending more carefully.
- Furthermore, the market often softens in the second year of the second term of a president, as the "honeymoon phase" wears off and investors are less hopeful about the prospects of seeing any of the red meat thrown their way as promised the campaigning period. This time should be no exception, as this president has become one of the earliest lame ducks in recent history. The GOP, despite its majority, is increasingly seen as ineffectual. Case in point: Whither privatization of social security?
- Finally, we are almost 4 years into a Bull market, albeit a weak one. But even weak bulls are usually followed by bear markets, and we're about due for one.