Several years ago people worried that recession would soon come and make stock prices plummet. Instead the economy kept growing and is now the longest expansion in U.S. history.
Reasons why recession was delayed:
1. Aggressive use of junk bond investing (by yield-starved investors) has provided extra funds for poor quality business; in previous cycles these businesses would have failed sooner thus triggering a recession.
2. Migratory capital from the EU and Japan, where desperate savers hurt by negative interest rates, have sent capital to the U.S. junk finance markets. (Junk finance can be junk bonds, Bank Loan Funds, Peer-to-Peer loans, BDCs, put option writing, and some Venture Capital funds that foolishly invest in over-hyped non-technical so-called “tech” companies that are and always will be unsound and insolvent).
3. Flight capital from EM countries, including China into the US.
4. Excessive stimulus from the unneeded 2017 tax cut.
5. The concentrated income/earnings power of two-income professional couples is more intense than in previous decades due to the phenomenon of assortive mating (where people tend to get married to someone equally prosperous instead of marrying a more economically diverse type of person). This allows these investors to incorrectly leap to the conclusion to become over-confident in investing because they are confident about their employment and family income.
6. The concentration of stable growing earning power amongst the class of professionals (doctors, engineers, etc.) who can afford to buy most of the stocks means that this group of investors may be more confident, and have deeper pockets, than previous generations of individual equity investors. Despite the problem of hidden unemployment for low paid blue-collar people, the upper middle class professionals are actually more in demand than in previous eras due to the rapid growth of technology, cyber-security, medicine, regulation, litigation, auditing, etc.
7. Ultra-low rates for mortgage and consumer loans makes carrying bigger debts less painful than in previous cycles.
8. Unprecedented global central bank Quantitative Easing has lowered interest rates from 2009 to 2018, making investors foolishly leap to the conclusion that if interest rates are low then stock prices should be higher using a naïve Discounted Cash Flow (DCF) model. In the case of Japan and Switzerland, the central bank has bought significant quantities of equity shares. This never occurred during recessions before 2008.
9. The wealth effect from QE has inflated stock prices thus rewarding sellers of put options which in turn made it cheaper to insure against stock crashes thus creating an economic cycle where low put option prices help to make equity prices to continue to rise and stocks’ volatility is consistently reduced (except for the “vol” crash of 2-5-2018). The lower the volatility and the lower interest rates are, then the more that put issuers are induced to offer more low cost put options, which in turn helps to increase stock prices. Rising wealth induces some consumers to overconsume, thus expanding the economy, which was the Fed’s goal with QE.
9. Trump administration’s reduction of regulatory obstacles may have increased business activities, thus stimulating the economy.
10. The growth of fracking in the U.S. resulted in an unexpected windfall of exports of oil, thus keeping the dollar’s value high, while lowering costs for consumers. The old economics cliché is that oil price increases are like a tax increase that acts to cause recessions, so oil price drops are like tax cuts.
11. Banks are still holding failed mortgages from the 2008 crash or delaying on foreclosing properties that have failed mortgages and are marking these to model instead of marking to market, which is clearly an incorrect description of economic reality. This never occurred during recessions before 2008.
Eventually these positive factors will either slow or reverse and the most aggressive uses of junk financing and put option writing will be curtailed when investors wake up and realize how dangerous they are. Possibly the 2020 election will result in tax and regulatory increases which will trigger a recession. A policy of excessive fiscal stimulus in 2021 could create higher interest rates thus destroying the DCF model of stock valuations that have been inflated by low interest rates, then stocks will go down.
Investors need independent financial advice about the risks of misunderstanding why recession has been slow to arrive.