Wall Street is gearing up for another record year on the equity market. On January 2, 2018, Nasdaq crossed 7,000. A day later, on January 3, 2018, S&P 500 reached 2,700. Dow Jones followed by passing over 25,000. The year 2018 has had a great start.
In times of market euphoria, investors tend to ignore the warning signs. It's important to remember there is never any shortage of potential threats that can trigger another significant market correction or economic recession. Here are eight threats to the market in 2018.
1. Government Shutdown
The Republican party has been invigorated after winning their most important battle of 2017. The GOP voted for the most extensive tax overhaul in 30 years, which promises to cut taxes for corporations and middle class. At the same time, it will introduce an additional $1.5 trillion to the budget deficit over 10 years, without counting for growth.
With a slim Senate majority and traitorous rifts inside the party, the GOP will have a hard time passing any significant legislation during 2018. The Senate leadership has already expressed their desire to work together with Democrats on the next bill, but they could not avoid a three-day government shutdown, and both parties have shown an enormous resistance to compromise on any level.
2. Geopolitical Crisis
There is a growing number of geopolitical threats that can compromise the global growth. The world is now a place where one miscalculation can lead to a human disaster, from cyber-war with Russia to nuclear tension with North Korea, ongoing unrest in the Middle East, shutting down NAFTA, populist governments taking over Europe, and hard Brexit negotiations.
China is looking to fill the vacuum left by the U.S. after scrapping the Trans-Pacific Trade Agreement. Russia and President Putin want to play a bigger role in world affairs. The remnants of ISIS are spread around the world and planning the next terrorist attack. The 16-year war in Afghanistan is still going with no resolution in sight. The tension between Iran and Saudi Arabia is on its highest level for years. The president must maneuver carefully in the dangerous waters of world politics where governments are becoming more and more protectionist and populist. (For related reading, see: Investing in Crisis, a High Risk-High Reward Strategy.)
3. Health Care Chaos
The GOP was unsuccessful in repealing the Affordable Care Act. However, they were able to remove the individual mandate as part of the recent tax bill. With the penalty going away in 2019, there will be no incentive for healthier individuals to sign up for health insurance. This will decrease the number of insured people and drive the cost of health care higher.
The Congress and Senate must find a solution to address the climbing health care cost. The alternative will lead to more healthy people dropping from the system, skyrocketing medical bills, social unrest and even economic slowdown.
4. Retail Meltdown
U.S. retail is in danger. In 2017, 19 retailers, including Toys R US, Aerosoles, Perfumania, True Religions and Gymboree, filed for bankruptcy protection. Many others like Teavana, Bebe, and Kenneth Cole closed all their physical locations to focus on online expansion. Despite rising consumer confidence and a record-high holiday shopping spree, traditional brick-and-mortar retailers are struggling to stay afloat. (For related reading, see: 2017: The Year of Retail Bankruptcies.)
Apart from a few big names, U.S. retailers are loaded with debt. According to Bloomberg, $100 million of high-yield retail debt was set to mature in 2017. This figure will rise to $1.9 billion in 2018 and will average $5 billion between 2019 to 2025. With rising interest rates and permanent drift towards online shopping, many physical stores will continue to close doors. Local economies relying heavily on retail jobs will suffer high unemployment rates in the coming years.
5. Consumer Debt Crunch
U.S. household debt reached $13 trillion in the third quarter of 2017, according to the New York Fed. Driven by low interest rates, mortgage debt increased to $8.7 trillion. Student debt has reached $1.36 trillion. Auto loan debt is $1.2 trillion. Bad auto loans have risen to 2.4%, and student debt delinquencies have reached 9.6%.
The rising interest rates can lead to more people failing on their loans, which can potentially trigger another crisis similar to 2008.
6. Interest Rate Hikes and Hyperinflation
The Federal Reserve is planning three interest rate hikes in 2018. Oil has slowly passed $60 a barrel. And the U.S. dollar reached $1.20 against the euro. Furthermore, U.S. manufacturing expanded in 2017, as gains in orders and production capped the strongest year for factories since 2004. Factories around the world have warned they are finding it increasingly hard to keep up with demand, potentially forcing them to raise prices. While CPI hovers around 1.7%, global markets have not priced in the prospects for higher inflation.
Unexpected spike in prices can lead to more rate hikes, which, combined with the growing budget deficit, can impose a higher risk of hyperinflation. (For related reading, see: An Introduction to Hyperinflation.)
7. Decreasing Retirement Savings
Only half of U.S. families have a retirement account. Of those with retirement savings, the average balance is just $60,000. Social Security had a $39 billion deficit in 2014 and will be entirely depleted by 2035.
With rising interest rates and GOP plans to cut entitlements, many Americans will not be able to retire at all or will suffer substantial income loss during their non-working years. Without an urgent reform, the U.S. Social Security system is a ticking timebomb that can hurt both businesses and families.
8. Mueller Investigation
The former FBI chief investigation is at full speed as more revelations about the Trump campaign appear on an almost daily basis. You'd need a crystal ball to predict the exact outcome, however, it is virtually certain there were people in the Trump circle who were pursuing their own personal interests. The initial theory of collusion and obstruction of justice is leading to allegations about money laundering. If the Mueller investigation proves those accusations, we could experience a political crisis not seen since Watergate.
Know Your Risks
Ignoring the warning signs is easy in the short-term. However, being aware of the threats to the market can help investors prepare for the next correction and the possibility of an economic recession.
(For more from this author, see: 6 Proven Strategies for Volatile Markets.)