Posted March 10, 2023
By Zach Scheidt
The Bear Case for Stocks
I’ve had a lot of people ask me recently what’s going on in the market and whether I think stocks are headed higher or lower. The answer is that we’re in a bit of a no man’s land.
On one hand, plenty of smart investors believe the market is headed straight up from here. On the other hand, many smart investors say that we’re in for a pullback.
Personally, I land somewhere in between. The market is hard to gauge, and depending on where you look, there’s a good case to make for either point of view.
This week, I got the chance to catch up with my colleague J-Rod for our monthly Lifetime Income Report Pro State of the Market call.
On the call, we talked about some of the challenges in play right now along with a few opportunities I see in other strong areas of the market.
I’m excited to share a portion of our conversation with you today. Click on the video below to watch a clip from our call where I cover a few of the biggest risks in our current market.
If you keep these factors in mind, you’ll be in great shape to protect the wealth you’ve worked so hard to save.
We'll start with the challenges and risks. (But don't think of me as incredibly pessimistic, because I do think there are tremendous opportunities out there.)
The first one is inflation. We're seeing wages remain stubbornly high, which means that people have money to spend. And that naturally drives prices higher.
We're also seeing a bit of waffling for housing prices. Rents for some apartments are coming down, while prices for homes are still relatively high.
Meanwhile, high interest rates make mortgages difficult if you buy a new home. So there's some ambiguity when it comes to inflation, but it's still very high and it's still a major concern.
This week's job market report will be very important. On Friday, we're going to get information about how many jobs were added to the economy in February.
You may remember when we had this call last month, we were kind of taken aback by how strong the January numbers were.
Now we're going to be watching these February numbers closely to see if that was just an anomaly or if we really are facing a stubbornly strong job market.
If the economy added a whole bunch of new jobs that we weren't expecting, you can expect to see some weakness in the overall market.
It tells us that the Fed isn’t doing enough to keep inflation down, that the employment level is too high, that people still have money to spend, and that they will keep driving inflation higher.
So the market is probably more focused on what the Fed's going to do than they are on the good news of adding new jobs.
Now, jobs are good; we definitely want to see people employed. But because they add to inflation, that causes a risk for the market.
This morning I heard an interesting take on jobs and I think it's worth thinking about.
Powell is focused on trying to cause layoffs or at least cool the job market, which is supposed to keep people from spending money and help to drive inflation lower.
But in some cases, it could hurt companies and their ability to produce goods and services that we need to buy. In other words, it could reduce the supply of things that we want.
Meanwhile, when people get laid off, they typically have severance packages. We have unemployment insurance and other safety nets to make sure that people aren't hurt terribly when they lose their job.
But what that does for the economy is it means that people still have money to spend even if they're laid off, which completely turns that whole idea of layoffs reducing inflation on its head.
Because if people still have money to spend and businesses aren't able to create as many products and services that we need, it just causes inflation to be even higher.
So there's some argument to be made that we're shooting ourselves in the foot to some degree with this focus on bringing employment lower.
Interest rates are incredibly important in the market that we're in right now. The Fed continues to talk a big game.
And this week even as we're talking right now, investors are reacting to Fed Chairman Powell's testimony in Washington.
He’s going before Congress and telling them what he expects and he's getting questioned, and it's a whole dog and pony show.
But what we're seeing from this is that Powell is still very, very focused on raising interest rates to cut inflation, and the market doesn't like seeing that.
We saw a big pullback in the market on Tuesday. And the jury's still out on what that long-term trend is going to be, but it's a risk that we need to keep in mind.
The next Fed announcement is going to be on March 22. The big question is, will interest rates be raised by 25 basis points, or will they go a little bit stronger and be raised by 50 basis points?
And then more importantly, we need to think farther down the road. What happens then? Is the Fed going to keep raising rates aggressively?
If so, that's probably going to put a lot of pressure on the market.
We've talked a lot about how interest rates affect different areas of the market. But one thing that we haven't talked about is now we're looking farther down the road to see higher interest rates.
And when you have higher interest rates, it makes it more difficult for companies who have debt to refinance their debt.
Most companies have bonds that mature a few years in the future. If you have $500 million that you're supposed to repay in 2024 or early 2025, the company has to come up with that money to repay its bond holders.
Typically what happens is that the loan is rolled. The company will issue more bonds, pay whatever the interest rate is then, and get the money from those bonds and pay off the existing bond holders.
Well, that's all well and good when interest rates are stable because the company can borrow money at the same price or at the same interest rate that it had before.
But now with interest rates moving higher and expected to stay higher for years, many companies are going to have a really hard time refinancing that debt.
And that causes some risks in two different ways.
On one side, we know that companies that are unstable or are just on the verge of being profitable are going to have a really hard time, and we could see defaults pick up.
That's a risk that a lot of people are talking about and that we know we need to be very careful about investing in companies that have too much debt.
But the other thing is companies who are solvent, companies who are profitable are still going to have to pay higher interest rates than they were before.
What that does is it causes us to look farther down the road and say, well, they're not going to make quite as much profit as we expect it.
They're still going to generate income, but they're not going to be quite as profitable because they have to pay higher interest rates starting in 2024 or 2025.
As we see investors start to recalibrate what they're expecting down the road, that could cause expectations for profits to come down.
And it could cause many of the stocks that we still like to pull back or at least not move higher as quickly as we expected before.
It's definitely a concern to keep in mind and something that we'll be watching very closely. And we’ll let you know which companies have the most risk here and also which companies don't.
And then another thing on the debt side that we want to focus on is that consumers are dealing with debt in different ways.
I saw an article recently that said consumers in their thirties now hold $3.8 trillion in debt. This is normal working families who have 2.4 kids and a two-bedroom house.
They're dealing with just a huge and growing level of debt because inflation is hitting them really hard, and they’re going to try and figure out how to stretch their budgets.
Meanwhile, affluent consumers have a lot of money to spend. If you look at the big picture for all consumers, there’s a lot of savings still left from the pandemic now ready to be spent.
And one thing to keep in mind is that since we've had a stock market rally so far this year, those consumers who have money in the bank will feel more confident about spending that money.
They're seeing their investments rise, so they don't feel like they have to keep that money in the bank as a safety net anymore.
That's going to drive consumer spending on more affluent things like travel and expensive luxury items. So that's another area for us to keep in mind as investors.