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The Stock Market is Dangerously Fragile

Despite recouping from last October’s selloff losses, market’s stability too closely tied to ephemeral and ever-changing events

Although the market continues to advance, approaching its all-time records, there are some worrisome signs about the stability of its continuing advance.

A prominent concern, is that every time there is adverse news on the “trade dispute with China,” the market reacts wildly and precipitously. This action/reaction song and dance has been going on for at least two years. But it is more disconcerting now, because, the market no longer has the benefits of the corporate tax cuts and profit growth is slowing from the heady record setting double-digit days of 2017-2018.

The resolution of our existing trade relations with China is a complex matter, that has a long, and for the U. S. , a disadvantageous history. Any analyst who believes the China question can be resolved quickly is not attuned to the geo-political and strategic adversarial relationship that has evolved between the two super powers.

Question for analysts calling for the market to continue its unheralded rise: what happens if tensions between China and the U. S. In the South China sea escalate?

Another cause for concern, is the market’s unusual sensitivity to the policy pronouncements or guidelines announced by the fed. Chairman Jerome Powell has said on previous occasions, that his preference is for adopting a wait and see approach, that provides the fed with flexibility in terms of how it reacts to slight changes in leading economic indicators.

No one knows for sure, how long the fed will continue to maintain its “Goldilocks” posture towards the economy. The fed has stated that if inflation minimally exceeds its target rate of 2%, then it may not need to react by raising interest rates, which has been the traditional monetary policy response for over fifty years.

The economy currently is in uncharted territory. The unemployment rate is the lowest it’s been since 1967. Wage increases have grown at the fastest rate in thirty years, yet, inflation has consistently been subdued. Can the economy maintain this momentum in the tenth year of the bull market/recovery? No one knows for sure.

Far too many investors, have read into Powell’s pronouncements only what they want to hear, namely, that there will be no further rate increases for the remainder of this year. An indication of how acclimated investors have become towards uncritically adopting this view, is that many analysts were expecting a reduction in rates sometime later this year. This fantasy was dispelled last week by Powell and like a child exhibiting a temper tantrum, the market reacted adversely. It cannot be stressed enough that this continuing delusion that the fed will keep the stock market on its upwards trajectory, may at some point, expose those who have shifted their portfolios’ into riskier asset classes.

Should a minor adjustment to interest rates occur, there is disappointing news on the trade front, there will be a disproportionate reaction in the market on the news. If this thin reed is the wall that separates continuing market advances and sporadic volatility, then many investors who have shifted into riskier assets on the hope that interest rates will remain unchanged, could be exposed if trade tensions with China worsen or the fed suddenly upends the conventional wisdom, with a rate hike.

If investors expectations that a trade deal is imminent or will be “worked out,” or that the fed will maintain its neutral rate policy at 2.25% prove to be erroneous, expect continuing volatility.

This article originally appeared in gurufocus, a value investing site

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