They say bull markets don’t die of old age.
With this one lasting for more than 10 years and gaining value by more than 340%, you’ve got to wonder how long it has left.
The best way to find that answer is to ask an entirely different question—that is:
Why do bull markets end?
Let’s find out…
Reason #1—Tighter Monetary Policy
The most popular cause, the one you hear financial pundits repeat over and over, is the tightening of monetary conditions—that is, the Fed raising interest rates too much or too fast.
The reason this leads to a recession is because a tighter monetary policy limits the amounts of money and of available credit in circulation.
This in turn slows the economy, limits economic growth potential, and, when the conditions tighten too much or too fast, can reverse economic expansion altogether.
It is understandable why this theory is so popular when you look at how many times tighter monetary policy has led to recession in the last few decades. This was the case in 1956, 1966, 1968, 1980, and 1990.
The 1980 example is probably the most illustrious one.
Paul Volcker, Fed chairman at the time, raised Fed funds rates to 20%, the highest in history, to rein back runaway inflation and save the U.S. currency from collapse.
Volcker’s method worked. Inflation fell from 14% to 7% in a year.
Unfortunately, however, it also led to a recession in 1981 that lasted 16 months and caused the S&P 500 to fall by 27%.
Verdict: While the Fed has tightened interest rate policy in recent years, I wouldn’t say they have hiked rates too far too fast, as they have done in the past.
The U.S. economy has remained strong, unemployment and inflation low, as interest rate hikes have been gradual and well telegraphed so as not to frighten the market.
Moreover, due to the global economic slowdown, the Fed is now lowering interest rates as a preemptive measure. So, now, monetary policy is loosening, not tightening.
Therefore, I don’t see Fed practices leading to recession.
Reason #2—Tighter Fiscal Policy
A less-known cause of recession—with similar mechanics to tighter monetary policy—is tighter fiscal policy.
Governments sometimes run loose fiscal policy to stimulate the economy. They do so by reducing taxes or investing in infrastructure, both of which increase the amount of money in circulation.
Again, when this policy is reversed, the amount of money in circulation decreases, slowing the economy. When the decrease is great enough, recession can follow.
This was the chain of events that played out in the early part of the 20th century, when Keynesian Economics first became popular.
Keynesians believed that government infrastructure spending was the answer to the Great Depression.
While their strategy worked, it stalled when the U.S. government slashed spending in 1937, leading to a stock market downturn and a subsequent recession.
The same thing happened in 1945, when the U.S. government cut back on its war spending spree, resulting in another downturn and recession.
Keynesian Economics are not a perfect solution.
Verdict: Trump’s 2018 tax cut was a form of fiscal stimulus. However, I don’t think it will trigger a recession.
First, the stimulus was small compared with those in 1937 and 1945.
Second, the effects of the tax cut have already begun to fade. If they were going to cause a recession, they already would have done so.
Third, for fiscal policy to tighten, the government would have to increase the taxes it cut. I don’t see Trump’s government doing that.
With democrats in the Oval Office, however… who knows.
Good investing,
Leon Wilfan
