Already we’ve seen signs of froth, especially in the FAANG stocks (Facebook Inc. FB, +1.09% Amazon.com Inc. AMZN, +0.97% Apple Inc. AAPL, +0.59% Netflix Inc. NFLX, +1.96% and Google parent Alphabet Inc. GOOG, +0.93% GOOGL, +0.99% where even value investors have piled in, chasing outsize performance.
Since those stocks sold off earlier this month, investors have switched back into the financial sector, which had fueled the post-election Trump rally. That kind of sector rotation is healthy and may extend this bull’s run.
But after eight years and a more than tripling of the Dow Jones Industrial Average DJIA, -0.27% and S&P 500 SPX, -0.06% it’s time to think about what could bring this bull market to a timely, or untimely, end.
Here are four of the most likely causes of the bull’s demise:
1. Recession
So, what are the chances of a recession? Very low right now. Job growth has slowed over the past few months and GDP is growing at only1.2%, but there aren’t the declines we usually see in recessions. I’m not counting on big fiscal stimulus packages from Washington, D.C. to boost growth much, but they might delay the next recession for a while.
Econbrowser’s recession index is at a mere 8.4%, which is about right for the rest of 2017. I’d bump the odds up to 20%-30% next year and higher in 2019, because of….
2. The Federal Reserve
As unemployment has dropped to 4.3%, the Federal Reserve has continued gradually raising interest rates. After the last Federal Open Market Committee meeting, Fed Chairwoman Janet Yellen indicated the rate-setting body was on track to raise the federal-funds rate three times in2017 and continue on that path next year, even though inflation is well below the Fed’s 2% target rate. She also said the Fed would begin shrinking its $4.5 trillion balance sheet, which ballooned during three rounds of quantitative easing during the financial crisis.
Currently at 1%-1.25%, fed funds remains historically low. Before the last two recessions and bear markets, it peaked at 6.5% in 2000 and5.25% seven years later, so it can rise a lot before it’s a threat to stocks. And continued slow GDP growth may keep Yellen or her successor from hiking too quickly or maybe at all. Yet the gradual rate hikes plus the steady reduction in the balance sheet could eventually put the kibosh on this bull.
Probability: 10%-20% in 2017, 20%-30%+ next year.
3. FAANG or unicorn crash
These stocks have accounted for so much of the market’s move over the last three years that any serious dislocation in this sector could bring the whole market down with it. Their fundamentals — earnings and revenue growth — are so solid it’s hard to imagine their stocks would collapse. But in 2000, Cisco Systems Inc. CSCO, -0.03% and others were similarly formidable, with real earnings growth and seemingly limitless prospects, and the bottom fell out on them, too. A severe disappointment by any of them — and it’s happened before — or the unraveling of one of the pre-IPO “unicorns” (Uber in particular, whose bad-boy CEO, Travis Kalanick, resigned under investor pressure Wednesday) could spark panic selling that would spread way beyond the friendly confines of Silicon Valley.
Probability: 10%-20% this year, 20%-30%+ in 2018.
4. War
As I wrote a couple of weeks ago, a war with North Korea is the markets’ biggest geopolitical black swan, because it would likely be cataclysmic, with hundreds of thousands dead, the world’s fifth-largest metro area, Seoul, suffering massive destruction, and perhaps even nuclear or chemical weapons unleashed on Japan or U.S. bases in the region.
Of these four possible scenarios, war is the most unpredictable, and its disruption would go far beyond the markets and the economy. If it happened, the price of oil or the Dow or the S&P 500 may well be the least of our worries.
Reference: Market Watch
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