Black Monday, August 5th was a powerful reminder to investors that the stock markets don’t just… go up, they sometimes go down. It wasn’t the end of the world.
Wall Street’s 3.0% drop on a daily basis is a big deal, but it doesn’t compare to October 1929, when the stock market fell 21% in two days, or October 1987, when the stock market lost 21% in one. day.
What caused the August 5th mini accident?
There are several suspects in the “murder”. Employment data released on Friday, August 2 showed a slowdown in job growth and a rise in the unemployment rate. The divergences were not extreme, but they caught the markets’ attention.
In fact, the August 5 decline began on August 2, giving the two-day downtrend more impact on investor behavior.
It is also true that in late July and early August many companies, especially those in the Big Tech sector (the technology companies), released earnings data for the quarter ended June 30 and heralded upcoming trends. Many of the earnings figures showed huge spending on artificial intelligence (AI) with little or no impact on revenue.
This was enough to force market analysts and investors to change attitudes towards the entire industry and redefine “fair prices”.
This attitude towards artificial intelligence led to many huge losses in stocks, such as Nvidia and Samsung, even before August 2nd and 5th.
The economy is in recession
There is something much bigger than markets behind all of this. It’s the economy. Warnings of the economy entering recession have become tangible signs.
Last Friday’s (9/8) unemployment figures were a sign. However, unemployment is not a leading indicator but captures developments in the economy with a delay. This means that the recession probably started in June or even May.
We won’t know for a few more months when the National Bureau of Economic Research will make the unofficial “official” announcement.
This downturn could be severe based on excess corporate inventories (indicating a decline in active demand) and a number of other technical indicators. A prolonged recession is consistent with the prediction of a long, slow decline in stocks.
What comes next?
To be clear, August 5th was not a “big crash”.
A drop of 25% or more over a period of a few weeks (similar to what we saw in March-April 2020) is always possible, but this correction has momentum that suggests it will bottom out and stabilize. The ‘buy the deep’ trend is still active
This doesn’t mean a sudden rally, but it could mean that the market could trade around the new low, with those who need cash (getting out) and those who bet on the decline to speculate…
When the crash will come is difficult to predict, even when one knows it will happen. But the consequences of a crash are even harder to predict.
The real impact of the August 5th mini-crash was the spike in volatility.
In place of solid gains from their portfolios, investors should now expect big bullish and bearish sessions within a broader downtrend.
Worse than a crash
We may actually be facing something worse than a crash.
We may be in for a long, slow descent to new lows that could mark a drop of 70% or more from the top (for example, the Dow 12,000).
Investors are familiar with the Dow’s 21% crash in 1929, but fewer know that the bottom didn’t come until June 1932, down 80% from its 1929 high.
Something similar happened in the 1970s where the Dow was 1,000 in 1969 and 1,000 in 1982. It went nowhere in 13 years (with volatility along the way).
Adjusted for inflation, the 1982 index was worth less than half of the 1969 index, so in real terms it lost over 50% of its asset value during those 13 years before a new bull market began.
The problem with a 25-year (1929-1954) or a 13-year (1969-1982) recovery is that many people don’t have the time to recoup their losses. Let’s be prepared.
A Fed rate cut is coming
Regarding the prospect of a rate cut by the Federal Reserve in September, many analysts wrote that the best way out for the Fed is to keep its head down and do nothing.
That’s what everyone expects from the Fed unless there’s an extreme market crash or a sharp rise in unemployment.” Well, we’ve just had the crash and the immediate rapid rise, so it’s clear that the Fed will cut rates in September.
But this is not a… free meal
The initial assumption that the Fed would not cut rates was based on the fact that inflation was still very high. This is still true.
Thus, the Fed will throw in the towel on inflation in order to calm the turmoil in the stock markets.
The Fed may end up with the worst of both worlds – persistent inflation and recession known as “stagflation.”
The Fed will only intervene when the stock market crashes, say, 20% or more in a few weeks, or when there is a “banking panic,” or both. We’re not there yet.
It could happen, but the situation right now is not bad enough for the Fed to intervene other than a 0.25% cut in September. Don’t wait for a 0.50% cut. The Fed doesn’t want you to panic, but they don’t want to appear panicked themselves.
The conflict with Trump
A rate cut in September puts Jerome Powell on a direct collision course with Donald Trump. That’s because the rate cut will come just six weeks before Election Day on November 5.
It will probably boost the stock market (in many ways the mere expectation of a rate cut has already boosted stocks after the August 5th mini-crash). In turn, this will boost the Democrats’ chances of winning the presidential election.
Trump has publicly stated that Powell should not cut rates so close to the election, and doing so should be considered a form of election interference by the Fed’s supposed policy neutrality.
Powell should be able to justify a rate cut using the economic slowdown and high stock market volatility as cover.
But if Trump wins the election, there may be a high price for Powell and the Fed to pay for this policy rate cut.
- In principle, all seats on the Fed’s board are chosen by the president.
- Trump could nominate allies like Judy Shelton, Larry Kudlow and Monica Crowley to fill those positions.
- It’s not clear that Trump could fire Powell (it’s possible, but it’s never been done before), but Powell’s term as president ends on May 15, 2026, so Trump could replace him relatively early in his second term of.
- Trump could also pass legislation (assuming Republicans control Congress) that could reduce the Fed’s powers and autonomy.
- This could include removing the “dual mandate” that requires the Fed to target unemployment and inflation at the same time (impossible to do, but the Fed is making the proposals).
- This would return the Fed to its original purpose of “sound money” and the role of lender of last resort.
So there is a lot at stake if Powell moves to cut rates. If Trump wins and Republicans take control of both houses of Congress, we could be dealing with a “nervous” Fed.
This could be a negative if the Fed were truly apolitical – the Fed should be independent of political pressures.
But since the Fed isn’t, a “nervous” Fed would be good for the economy and the American people as a whole – so maybe Donald Trump will get his gun!
