When the next bear market hits stocks, Wall Street will feel the pain, as it always does.
Hedge funds will take deep losses, trading desks will flail, and the volatile environment will make it more difficult for companies to tap capital markets.
But outside the nation’s financial epicenter, the stakes are arguably higher.
That’s not because Main Street is more vulnerable to a stock-centered meltdown — in fact, the opposite is true. It’s because such steep sell-offs have historically signaled that the economy is in its final stage and that a recession is near.
And while economic collapses aren’t good for anyone, it’s everyday Americans who are left particularly exposed, their very livelihoods threatened. If Main Street’s lagging recovery from the most recent financial crisis is any indication, they will be playing catch-up for years after Wall Street regains its footing.
That is why the perilous situation unfolding in the US consumer market is so troubling. The household savings rate is now sitting at its lowest level since the previous crisis, leaving people no choice but to load up on more debt if they wish to keep consuming.
One firm’s ominous warning
The historically low household savings rate has caught the eye of Bernstein, which is now at least partially reconsidering its positive economic outlook for 2018.
According to the firm, recent growth has been a function of this lowered savings rate, which has boosted household wealth. If the measure were to reverse off recent lows and start heading higher, that could put a serious damper on consumption, Bernstein says.
So what could send it higher? A drastic market event that would prompt Americans on Main Street to start adding to savings amid faltering confidence. You know, like a 20% bear market sell-off.
It may not be Bernstein’s base case, but if stocks do see a plunge to that degree, all bets will be off.
“A big financial shock — which is a plausible scenario for 2018 — not only would damage the consumption forecast but could end the expansion itself,” Philipp Carlsson-Szlezak, an economist at Bernstein, wrote in a client note. “For 2018 it remains a core cyclical recession scenario in our coverage.”
The market’s most outspoken bear agrees
John Hussman, the former economics professor who is now president of the Hussman Investment Trust, agrees wholeheartedly. One of the market’s most outspoken bears, Hussman has no shortage of fear-inducing arguments, and his comments about the savings rate are especially pointed.
At the center of his argument is the blistering profit growth being enjoyed by US corporations. Frequently cited as the foremost tailwind of continued stock gains, Hussman takes the opposing view, suggesting that earnings can be this strong only when consumers are taking on outsize loads of debt.
It’s all part of Hussman’s belief that an “economic Ponzi scheme” is playing out as the economy relies on the constant creation of low-grade debt to finance consumption.
And that debt has been easily accessible given the highly accommodative lending conditions that have characterized much of the recovery from the latest financial crisis. If you provide companies and everyday people with access to cheap capital, they’re going to take advantage every time, and you end up in a situation like this.
“Record corporate profits are essentially the upside-down, mirror image of a dysfunctional economy going into extreme indebtedness,” he wrote in a recent blog post. “Combine this with the fact that corporate profits move inversely to wage and salary income, and it should be evident that the surface prosperity of the U.S. economy masks a Ponzi dynamic underneath.”
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