Bull markets don’t die of old age, the saying goes. And technically, it’s true: While earnings growth is strong and interest rates are low, it doesn’t matter how long a market has been rising.
But as bull markets age, valuations increase and investors throw caution to the winds, making stocks more vulnerable to external shocks.
Last week I wrote that I expected the economy and stocks to remain strong, although the S&P 500 index SPX, +0.67% and the Dow Jones Industrial Average DJIA, +0.89% won’t do quite this year as well as they did in 2017. But equities are inherently risky, and here are three things that could wreck the bullish party.
• Inflation. Wage increases have remained modest even as the economy approaches full employment. Last week’s jobs report pegged year-over-year hourly earnings growth at 2.5% in December, in line with where it’s been throughout 2017.
Meanwhile, the Consumer Price Index, excluding food and energy, rose at only a 1.7% annual clip in November. Using a slightly different measure, members of the rate-setting Federal Open Market Committee don’t expect core inflation to hit 2% until 2019. That’s the Federal Reserve’s target, and the FOMC won’t raise the federal funds rate more rapidly until we get there.
But earlier this month The Wall Street Journal reported that sub-3% unemployment in cities such as Minneapolis, Denver, and Fort Myers, Fla., have caused businesses to raise pay to keep or attract employees. If that becomes more widespread—and remember, 18 states and 20 cities raised their minimum wage on Jan. 1—inflation may pick up quicker than we think, and so would rate hikes, a huge negative surprise for investors.
• Politics. Didn’t we just have an election? Well, here come the 2018 midterms, and President Trump and both parties in Congress will be placating their bases and playing to the crowd. That’s why I don’t expect much bipartisanship in Washington this year.
Democrats and Republicans are set to clash over so-called “Dreamers” (roughly 800,000 undocumented young people who were protected from deportation by an executive order signed by President Obama in 2012) and tougher immigration laws and a border wall favored by President Trump (who will now ask U.S. taxpayers, not Mexico, to pay for it). That could lead to a government shutdown and a temporary fix that would last until after the midterms. I see the same thing happening with the debt ceiling: Avoiding default may be one of the few things Democrats and Republicans could agree on. If they don’t, look out below.
As for the midterms, I think the Democrats will take back the House of Representatives, but gerrymandering and a strong economy will keep their majority narrow. I also wouldn’t be surprised to see an evenly split Senate. That’s a recipe for gridlock (and possible impeachment hearings in the House) in 2019, but investors won’t care, because they already got what they wanted: tax cuts.
• War and geopolitical crisis.I’ve written extensively about North Korea, so I won’t repeat myself except to say the risk of war, even nuclear war, may be rising. War hawk Sen. Lindsey Graham (R-S.C.) said the chance President Trump would use military force would rise from “30% to 70%” if leader Kim Jong Un tests another nuclear weapon. Mike Mullen, former chairman of the Joint Chiefs of Staff, said we were “closer… to a nuclear war with North Korea…than we have ever been.” That’s a retired four-star admiral talking, folks, not some “snowflake.”
But don’t ignore other hot spots. Domestic dissent may prompt Shi’ite Iran to step up its regional confrontation with Sunni Saudi Arabia. One proxy war, in Yemen, is particularly dangerous: Late last year, a missile fired by Iranian-backed Houthis in Yemen was shot down before it hit the royal palace in Riyadh. A hot war between Saudi Arabia and Iran would cause oil prices to soar.
Renewed talk of “an aggressive trade crackdown” on China caused some market jitters early Monday, but we’ll see how it plays out. A trade war with China would definitely cause a big market correction, maybe more. But along with hot wars, politics, and surprise inflation, it’s the only thing that can stop a bull market that just doesn’t know when to quit.
Howard R. Gold is a MarketWatch columnist and founder and editor of GoldenEgg Investing, which offers exclusive market commentary and simple, low-cost, low-risk retirement investing plans. Follow him on Twitter @howardrgold.