Stocks crashed hard today. The Russell Small cap index was down 4.43%, the SP down 3.24%. The ten year Treasury yield dropped to 2.91%, far below the recent high of 3.23%. The 10 – 2 Treasury spread narrowed to 10 bps, it had been in a range of 22 to 32 bps for the past year. At this pace the Treasury 10 – 2 spread will be inverted, a classic sign of a recession.
Investing in stocks in the past decade has been dominated by the psychological aspects of technical trading, including “momentum”. But now momentum is broken, or soon will be. Many bullish investors may secretly feel stocks are overpriced and once the momentum trading turns against the bulls they will flee the market and park their assets in bonds, making yields go down.
The fiscal stimulus has been used up, along with the political capital needed to legislate the program. Thus fiscal stimulation may not be quickly available in the coming crash, resulting in an unmoderated crash that could pick up momentum. Monetary policy, such as cutting rates by 2% won’t stimulate the economy because it will hurt retirees who will react by cutting back on purchases.
Assuming no stimulus then stocks will go down until they reach fair value of 1,800 or even 1,400 for the SP, plus a brief overshoot of an extra 20% below those numbers.
The system has boxed itself in because the system has a foolish measurement of unemployment that claims to be full employment and thus it appears wrong to stimulate if the economy is in full employment. A better measure of employment would need to exclude those with the lowest quartile of job income as these minimum wage jobs are not economically viable either for causing inflation or for stimulating the economy through consumption.
When the market finishes liquidating its mistakes (or is close to that point) and reaches equilibrium then it will be time to exit bonds and buy stocks.
Investors need independent financial advice about the risks of a stock market crash.