These economic indicators point to a stock market crash


Whether you’ve been investing for decades or bought your first stock this year, 2020 will almost certainly go down in the history books for its craziness and unpredictability.

Due to the uncertainty caused by the 2019 coronavirus disease (COVID-19) pandemic, the first quarter of 2020 witnessed the fastest stock market crash in history. All in all, the benchmark S&P 500 (SNPINDEX: ^ GSPC) lost 34% of its value in just 33 calendar days. In some context, previous bear market corrections took around 11 months to reach a 30% decline. The coronavirus fix did it in less than five weeks.

Then there was the second quarter, which produced the strongest rally investors have seen in 22 years. The wide-base S&P 500 is now back for the year, with the technology Nasdaq Composite having recorded more than two dozen record highs since the March low.

Still, it looks like a catastrophe is looming for stocks.

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While Wall Street and Main Street are not tied at the hip, three economic indicators suggest the stock market is in really big trouble and heading for a crash.

The bond market tells the story

For starters, the 10-year US Treasury bill portends a bumpy road for the US economy and stocks. Last week, the 10-year T bond closed with a yield of 0.536%, marking its second-lowest daily close of all time. The only time we saw a drop in the 10-year bond yield was during the March 2020 bear market chaos (0.499%), and it only lasted a few hours.

In an ideal world, investors buy bonds during times of fear and then switch back to stocks when they feel comfortable with the US economy and the growth of public companies. Since the price of a bond and its yield have an inverse relationship, an aggressive bond buy will cause yields to persistently decline. The point is, if yields fall too much, potentially to the point of losing real money to inflation, we would expect investors to sell their bonds and switch to stocks. Obviously, given the sharp drop in yield over 10 years, this is not happening.

A near-record yield on the 10-year T bond with a stock market near an all-time high seems to indicate an exceptional distrust of equities, to the point where real money losses due to inflation have grown larger. acceptable. than the idea of ​​investing in stocks.

Yes, the stock market has been in a massive rally mode since March 23, but the bond market advises serious caution.

A businessman in a suit holding a cardboard sign that reads, looking for a job.

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The underutilization of labor is uncommon

Second, I would like to draw your attention to the rate of labor underutilization in the United States.

Most people are familiar with the unemployment rate in the United States, which measures the total number of unemployed as a percentage of the civilian labor force. Due to non-essential COVID-19-related business closures in most US states in March and April, the US unemployment rate reached levels not seen consistently since the 1930s. In June 2020, the Unemployment rate in the United States was 11.1%, still 110 basis points above the maximum unemployment rate during the Great Recession.

But there is an even more worrying number to fear: the underutilization of the workforce. According to measurements from the Bureau of Labor Statistics, labor underutilization takes into account the unemployment rate, as well as marginally attached workers and workers employed part-time for economic reasons. In other words, it is a measure of those who are unemployed, as well as those who are forced to work part-time, or to a job well below their skills.

Prior to each of the last three recessions, labor underutilization had reached a low of 6.7% to 7.9%. During the COVID-19 pandemic, it initially climbed to 22.8% and remains at 18%, as of June 2020. This means that nearly a fifth of the civilian workforce is either unemployed or stuck in a position where her skills were not used properly or were forced to work part time. This can lead to an army of discouraged workers and can have a negative impact on the operational efficiency of companies. It will take years to bring this underutilization rate back to a “normal” level.

A car key fob and a stack of hundred dollar bills on top of loan application paperwork.

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Auto loan delinquencies are a house of cards

A third economic indicator that suggests the stock market is in big trouble is auto loan delinquencies.

What you are probably thinking is that I am going to insist on the increase in delinquencies linked to the COVID-19 pandemic; and you are partially right. The real problem, however, is that auto loan delinquencies have been increasing since 2012, long before the coronavirus turned our world upside down.

According to data provided by the New York Federal Reserve, delinquencies on auto loans that were at least 90 days past due reached an all-time high in the fourth quarter of 2018, at least based on 19 years of record keeping. from the New York Fed. Meanwhile, the American Bankers Association has pegged auto loan delinquencies at an eight-year high, starting in the third quarter of 2019. Your favorite source may vary a bit, but the data all tells the same story: Car owners don’t pay their bills on time, if at all.

To be clear, the auto loan market is nowhere near the same size as the mortgage origination market that crippled the financial sector in 2008-2009. Again, this is not a negligible amount either. Based on data from the Federal Reserve Board of Governors, there are nearly $ 1.19 trillion in auto loans outstanding in the first quarter of 2020. If we find that something like 1 in 10 of these loans default for a prolonged period, it will hurt the monetary centers and regional banks that originate these loans.

A person who counts a stack of hundred dollar bills in his hands.

Image source: Getty Images.

Have dry powder on hand

If those economic indicators weren’t enough, history also shows that double-digit percentage corrections have occurred, without fail, after each of the last eight bear market rebounds.

However, none of this should scare investors enough to sell high quality companies. It’s never a bad idea to assess whether your investment theses are still holding up, but it’s always best to hold on to innovative and changing companies for long periods of time.

The only thing you’ll want to do to prepare for a possible stock market crash or correction is to have cash on hand. While not all of us have the dry powder that Warren Buffett works with, it’s important to have cash on hand to put to work during times of panic and fear. Remember, no matter how severe a correction or a bear market, every downward movement in the stock market has ultimately been erased by a bullish rally.

While I expect a lot of turmoil in the near future, I also see plenty of reason to believe that equity valuations will be higher in five to ten years.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are motley! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.

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