Regardless of whether you've been investing for decades or you purchased your first stock this year, 2020 will almost certainly go down in the history books for its craziness and unpredictability.
Due to the uncertainty caused by the coronavirus disease 2019 (COVID-19) pandemic, the first quarter of 2020 witnessed the quickest bear market crash in history. All told, the benchmark S&P 500 (^GSPC -1.03%) shed 34% of its value in just 33 calendar days. For some context here, previous bear-market corrections have taken approximately 11 months to reach a decline of 30%. The coronavirus correction did it in less than five weeks.
Then there was the second quarter, which brought about the strongest rally investors have witnessed in 22 years. The broad-based S&P 500 is now back up for the year, with the tech-heavy Nasdaq Composite having logged more than two dozen record-closing highs since the March bottom.
Yet it would appear that disaster is looming for equities.
Though Wall Street and Main Street aren't attached at the hip, three economic indicators would suggest that the stock market is in very big trouble and headed for a crash.
The bond market tells the tale
To begin with, the 10-year U.S. Treasury bond is portending that a bumpy road lies ahead for the U.S. economy and equities. Last week, the 10-year T-bond closed with a yield of 0.536%, marking its second-lowest daily close of all-time. The only time we've witnessed a lower yield on the 10-year bond was during the March 2020 bear-market mayhem (0.499%), and it lasted for only a few hours.
In an ideal world, investors buy bonds during periods of fear, then pivot back to stocks when they feel comfortable about the U.S. economy and growth in public companies. Since the price of a bond and its yield have an inverse relationship, aggressive bond-buying will lead to a persistent decline in yields. The thing is, if yields dip too much, potentially to the point where they result in real money being lost to inflation, we'd expect to see investors sell their bonds and move into equities. Clearly, based on the precipitous decline in yield on the 10-year, this isn't happening.
A near record-low yield on the 10-year T-bond with the stock market near an all-time high would appear to indicate an exceptional amount of distrust in equities, to the point where real-money losses to inflation has become more palatable than the idea of investing in stocks.
Yes, the stock market has been in big-time rally mode since March 23, but the bond market would advise some serious caution.
Labor underutilization is off the charts
Secondly, I'd like to turn your attention to the U.S. labor underutilization rate.
Most folks are well aware of the U.S. unemployment rate, which measures the total number of unemployed persons as a percentage of the civilian labor force. Because of the COVID-19 nonessential business shutdowns in most U.S. states throughout March and April, the U.S. unemployment rate spiked to levels not seen on a consistent basis since the 1930s. As of June 2020, the U.S. unemployment rate stood at 11.1%, which still a full 110 basis points higher than the peak unemployment rate during the Great Recession.
But there's an even more ominous figure to be concerned about: labor underutilization. According to measurements from the Bureau of Labor Statistics, labor underutilization takes into account the unemployment rate, as well as marginally attached workers and workers employed part-time for economic reasons. In other words, it's a measure of folks who are out of work, as well as those who are forced into part-time employment, or employment that's well below their skill set.
Prior to each of the past three recessions, labor underutilization bottomed between 6.7% and 7.9%. During the COVID-19 pandemic it initially spiked to 22.8% and remains at 18%, as of June 2020. What this means is nearly a fifth of the civilian labor force are either unemployed, stuck in a position where their skills aren't being used properly, or have been forced into part-time work. This can lead to an army of discouraged workers and may negatively impact the operating efficiency of businesses. It's going to take years to whittle this underutilization rate back to a "normal" level.
Auto loan delinquencies are a house of cards
A third economic indicator that suggests the stock market is in big trouble is auto loan delinquencies.
What you're probably thinking is that I'm going to harp on rising loan delinquencies tied to the COVID-19 pandemic; and you're partially correct. The real issue, though, is that auto loan delinquencies have been rising since 2012, long before the coronavirus turned our world upside down.
According to data supplied by the New York Federal Reserve, auto loan delinquencies that were at least 90 days in arrears hit an all-time high during the fourth quarter of 2018, at least based on the New York Fed's 19 years of recordkeeping. Meanwhile, the American Bankers Association pegged auto loan delinquencies at an eight-year high, as of the third quarter of 2019. Your preferred source may vary a bit, but the data all tells the same story: Car owners aren't paying their bills on-time, if at all.
To be clear, the auto loan market is nowhere near the same size as the mortgage origination market that crippled the financial sector in 2008-2009. Then again, it's not a negligible amount, either. Based on data from Federal Reserve Board of Governors, there's nearly $1.19 trillion in outstanding motor vehicle loans, as of Q1 2020. If we see something like 1 in 10 of these loans default for an extended period of time, that's going to put a hurting on money-center and regional banks that originated these loans.
Have dry powder at the ready
Should these economic indicators not be enough, history also shows that double-digit percentage corrections have occurred, without fail, following each of the past eight bear-market bounces.
However, none of this should scare investors enough to sell out of high-quality companies. It's never a bad idea to evaluate whether your investment theses still hold water, but it's always best to hang onto game-changing and innovative businesses for long periods of time.
The one thing you will want to do in preparation for an eventual stock market crash or correction is have some cash at the ready. While not all of us have the dry powder that Warren Buffett is working with, it's important to have cash on hand to put to work during periods of panic and fear. Remember, no matter how steep a correction or bear market might be, every downward move in the stock market has eventually been erased by a bull-market rally.
While I'm expecting plenty of turbulence in the near future, I also see ample reason to believe that equity valuations will be higher in five to 10 years.