Wall Street’s Four Bullish Views Will Likely Reverse

The stock market’s behavior is the gauge by which we can measure Wall Street’s attitude and outlook. Clearly, today’s reading continues to be one of bullish optimism.

However, there is a problem with following Wall Street’s current enthusiasm. The four bullish views cited as reasons to own stocks carry the risk of having reality chip away at the optimistic rationale.

Today’s four bullish views

First is artificial intelligence. Like the many unique developments throughout history, AI has created a widespread rush of action, ideas, strategies, forecasts and money – particularly equity financing so everybody can get rich. Importantly, the initial stage typically supports widespread bullishness as most of the equity investments blossom. They are boosted by both positive expectations and Wall Street’s optimism. However, reality eventually spoils the fun, and the excessive bullish activities begin their inevitable shakeout.

Second is inflation. Today’s consensus is that inflation is mostly defeated, so the Federal Reserve need not tighten money and raise interest rates. However, the U.S. and other developed countries are now in self-sustaining inflation cycles. The proof is in the amount of price raising that has compounded throughout the economies. Price rises for producers/sellers mean cost rises for users/buyers, thereby leading to a chain of more price/cost rises. Additionally, labor, the initial laggard in inflation adjusting, is now fully engaged in the inflation cycle, thus helping raise costs more.

When in an inflation cycle, the 12-month inflation rate is misleading. Instead, it is the compounded inflation rate from the cycle’s beginning that matters to all parties. Thus, the current commentary about a 12-month 3% rise is irrelevant. Instead, it is the large, 5-year 22% inflation in this Covid period that counts. Why? Because the various parties are in different stages of trying keep up with, catch up to, or get ahead of the inflation cycle.

Third is the U.S. Government debt. In November 2023, Moody’s put the U.S. debt rating on a negative outlook. However, that old news has been left behind. After all, Moody’s never followed through.

But rating agencies rarely act precipitously, particularly about a country’s debt rating. That means the past reasons for their negative viewpoint are still relevant. Moreover, the political situation (my underlining, below) has become more critical.

“New York, November 10, 2023 — Moody’s Investors Service (Moody’s) has today changed the outlook on Government of United States of America’s (US) ratings to negative from stable and affirmed the long-term issuer and senior unsecured ratings at Aaa.

“The key driver of the outlook change to negative is Moody’s assessment that the downside risks to the US’ fiscal strength have increased and may no longer be fully offset by the sovereign’s unique credit strengths. In the context of higher interest rates, without effective fiscal policy measures to reduce government spending or increase revenues, Moody’s expects that the US’ fiscal deficits will remain very large, significantly weakening debt affordability. Continued political polarization within US Congress raises the risk that successive governments will not be able to reach consensus on a fiscal plan to slow the decline in debt affordability.“

Fourth is Donald Trump’s presidency. Trump’s election and inauguration produced stock market optimism. The key expectation was for an improved business environment. However, the post-election political environment has increased uncertainty markedly (and the stock market dislikes uncertainty).

Uncertainty’s sharp rise has been caused by the dramatic scope, size and seriousness of the actions being taken. Moreover, the decisions and steps taken diverge significantly from normality. Heightening that considerable uncertainty is the widespread removal and replacement of career government employees and officers.

The bottom line: Dependence on dreams raises the risk of disappointment

• Artificial Intelligence is here to stay, but not so the easy, big payoffs.
• Inflation also is here to stay with the added risk of even faster price rises
• The U.S. House and Senate are putting together separate budgets that depend on more borrowing. Whatever the outcome, Moody’s will have new data to analyze the debt increase and the political situation
• The Trump presidency has promised many benefits from shaking up the U.S. government. Instead, the high uncertainty could shake up investors