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A House of Cards on Stilts
James Rickards

What’s driving the current stock market frenzy? Is it a new bubble pure and simple? Is it driven by fundamentals? Does the Fed play an important role?

Let’s look at these factors and make a forecast of stock market index levels based on these and other inputs.

Trends in stock prices over the past year have largely been a function of market expectations about Fed rate cuts and market euphoria over strong economic data, including low unemployment rates.

Another factor is the upward momentum for all stocks due to the AI-inspired frenzy now going on. While these price drivers are easy to spot and explain, it’s the case that they mask a much more troubling economic reality that will emerge soon to push stock markets significantly lower.

Wall Street’s Been Wrong for Two Years

The S&P 500 index hit an interim low of 3,855 per share last March. This came at a time when the Fed was still raising interest rates, and Wall Street expectations of a “pivot” to rate cuts were in ruins.

Wall Street has been wrong about the pivot for almost two years and they’re still wrong today.

On March 22, 2023, the Fed raised the target rate for federal funds by 0.25% to 5.00%, a further step in the monetary tightening cycle that began the previous March, and a further blow to the pivot narrative. This accounted in part for the interim low in the S&P 500 index.

From there, the S&P 500 rallied to 4,589 on July 31, a near-20% gain in just over four months.

This was due to the Fed’s decision to hold its target rate steady at their June 14, 2023, meeting along with more pivot cheerleading from Wall Street and the growth of the “soft landing” narrative that promised lower rates without a recession.

But this narrative hit a brick wall (again) when the Fed raised interest rates another 0.50% to 5.50% contrary to the Wall Street fairy tale. Beginning on July 31, the S&P 500 fell from 4,589 to 4,117 on Oct. 27, a 10% reversal.

The S&P index had fallen back to about where it was on April 3, 2023, when the latest round of pivot euphoria began.

Narratives Die Hard

Still, narratives die hard. Over the course of the September, November and December 2023 Fed meetings, it became clear that the July rate hike really was the peak.

The Fed gave zero indication that they were ready to cut rates (the infamous pivot), but Wall Street took up the pivot narrative and ran with it anyway.

The S&P 500 index soared to over 5,130 10 days ago, a 25% rally in six months. This rally was helped along not only by the pivot narrative but also by stronger-than-expected GDP growth in Q4 2023, stronger than expected job creation in January and February 2024, and the broader market euphoria surrounding all things AI-related.

There are numerous flaws in this happy narrative surrounding the stock market rally.

The first is that the strong GDP growth has been powered not by productivity gains or private-sector investment but by government spending. Growth in GDP has only been about 40% of growth in the national debt over the same time period.

The Keynesian “Multiplier”

Put differently, this means a neo-Keynesian multiplier of 0.40% compared to the much-touted multiplier of 1.25% or higher that deficit cheerleaders used to expect.

With a 1.25% multiplier, you borrow a dollar, spend a dollar and get $1.25 of growth (assuming the expenditure is not totally wasted and the economy has some spare capacity in terms of labor and capacity utilization).

With a 0.40% multiplier, you borrow a dollar, spend a dollar and get only $0.40 of growth. In short, your debt is growing faster than your economy, a completely non-sustainable state of affairs.

As the debt-to-GDP ratio goes higher, growth slows even more unless the government reaches into its bag of tricks and stokes hyperinflation. That gives you nominal growth (to deal with nominal debt). But real value is destroyed and bad debts soar.

House of Mirrors

The same house of mirrors applies to the low unemployment rate. This headline number (currently 3.9%) is based on the so-called establishment (employer) survey. The alternative household (individual) survey is showing weaker job creation.

Both surveys are glossing over the fact that most job creation is in the part-time rather than full-time category. Both surveys ignore the declining labor force participation rate (basically eligible workers who have dropped out of the workforce and are not counted as unemployed), declining hours worked and declining real wages.

Other data shows that while layoffs are not increasing dramatically, new hiring has hit the wall and is close to zero. Employment data is a lagging indicator. This means that when the data starts to turn downward, the recession is already here. We may be at that inflection point right now.

Gemini GPT – The Damage Is Done

Finally, the AI-related euphoria in the stock market is just that — euphoria. It’s a classic bubble in the making. AI is real and some hardware manufacturers such as Nvidia, AMD and Intel may deserve higher valuations.

But the GPT apps produced by Google, OpenAI and Microsoft are turning out to be not much more than novelties and defective ones at that.

A recent prompt to Google’s Gemini AI app for an image of a pope produced an array of Black women and an indigenous shaman. There hasn’t been a black, a woman or a shaman pope.

It turns out the product had been programmed to eliminate white people. Gemini was quickly pulled off the market but the reputational damage was done. This AI/GPT frenzy is a thin reed on which to rest any valuation.

The Bottom Line

When the economy falls in line with the hard data, loan losses (especially in credit cards and auto loans) will soar and financial institution stock prices will crash. The popping of the AI bubble will act as a force multiplier taking all stocks down with it.

The Fed may cut rates in September but (as usual for the Fed) it will be too late — the recession will already be here. Bank loan losses will overwhelm any slight gain in credit spreads.

The result will be an across-the-board tightening of monetary conditions typical of the early stage of a recession. The Fed will not be able to ride to the rescue.

So-called QE is not any kind of stimulus because the money created is sterilized in the form of excess reserves on the Fed balance sheet; it does not increase lending or spending in the real economy.

Stocks will plunge with no likely means of support



James G. Rickards is the editor of Strategic Intelligence, the latest newsletter from Agora Financial. He is an American lawyer, economist, and investment banker with 35 years of experience working in capital markets on Wall Street. He was the principal negotiator of the rescue of Long-Term Capital Management L.P. (LTCM) by the U.S Federal Reserve in 1998. His clients include institutional investors and government directorates.

His work is regularly featured in the Financial Times, Evening Standard, New York Times, The Telegraph, and Washington Post, and he is frequently a guest on BBC, RTE Irish National Radio, CNN, NPR, CSPAN, CNBC, Bloomberg, Fox, and The Wall Street Journal. He has contributed as an advisor on capital markets to the U.S. intelligence community, and at the Office of the Secretary of Defense in the Pentagon.

Rickards is the author of The New Case for Gold (April 2016), and three New York Times best sellers, The Death of Money (2014), Currency Wars (2011), The Road to Ruin (2016) from Penguin Random House.

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