Reversal or correction in the market for the next 20 years

Since mid-October, the global equities market has bounced off a low and raced to what looks to be an over-extension of valuation. Are we looking at a potential sell-off in the near future? The potential for a sell-off is going to come down to a number of economic factors and how investors interpret them. This kind of adjustment is a normal and necessary part of financial instrument value. They rarely move in a linear fashion for an extended period. There is always periods of correction where investors leave the markets to either bank profits or minimize losses. Will this change affect the risk asset uptrend that began in the early 1980’s?

A potential answer can be found in economic theorycrafting. Thomas Piketty postulated that a rising wealth/income model could not naturally be maintained in the long term. The wealth/income model is generally stable in many economic models. The French and British economies have both held to Piketty’s wealth/income model for centuries. It appears that the opposite has been true for the past few decades. Some attribute it to interest rates and greater national profits. In America, income gap is becoming a more talked about subject. It is impossible to survive on a single person’s minimum wage in many areas of the country. The disparity has gone unaddressed and has been allowed to widen for decades.The result is more money going into the pockets of the rich instead of into the pockets of poor. It is theorized that this problem is leading to stagnation because the rich are much fewer in number and spend much less than the poor. In turn, this lowers demand which incites policy makers to take action to combat the perceived problem. It can trigger financial expansion through adjustment of taxes, interest rates, and subsidies which, in turn, causes greater disparity that policy makers feel compelled to take action on. Should this loop continue in the long-term, it has the potential to further widen the gap and increase the private sector debt/GDP ratio.The falling interest rates encourage further borrowing while it is theorized that rising asset prices, particularly in housing, allow an increase in credit worthiness and the ability to borrow. One point this theory fails to address is the lack of American confidence in wanting to seek out those loans. Rate shopping is significantly lower than it was even a year ago. There will have to be more confidence in the well-being of the economy before we should reasonably expect an increase in mortgages and housing.

There needs to be significant changes in a few key areas if we are to expect a real reversal instead of just a correction and continuation. Demand would rise if more money was going into the pockets of the poor because there is simply more of them to spend. The combination of technical progress and globalization of economies makes this exceptionally challenging as American manufacturers are unable to get nearly as much out of a dollar as Asian manufacturers who have much larger populations.

The trend that has been in placed for the past 35 years is not going to spontaneously reverse. There needs to be a significant catalyst that can spur a reversal. Policy changes like the following could serve as the catalyst:

-A shift towards equity funding instead of debt funding. This would hit investment values and force them down.
-A shift towards fiscal expansion would help adjust interest rates, which should alter the flow of income.
-A significant raise in minimum wage at a nationwide level.

Any significant changes, like the examples given, would require a lot of political clout and ability. These aren’t the kind of changes that are typical in the American financial sector. Any of them could have a rippling effect on associated markets. Given the present economic and political climate, that isn’t likely to happen. There’s no reason to assume that the 35 year trend is ready to reverse. Correct from the current extreme? Certainly. Share your view below.

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One response to “Reversal or correction in the market for the next 20 years

  1. Pingback: The World Bank Issues Warnings About Climate Chage | Alpha Banker·

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