The Bursting Bubble: Is Wall Street Heading For A Crash?

The Federal Reserve (Fed) has been in tightening mode since March 2022, aiming to get control of runaway inflation. Costs have gone up and up for consumers and producers alike, and there was clearly a need to get a handle on things. 

However, rates are now at a 23-year high, and there are mounting concerns that there is a potential bursting of the US credit bubble. With inflation finally showing signs of easing, there is growing speculation about whether the Fed will soon begin cutting rates – but will it be too late? 

Source: Tradingeconomics

Despite some progress being made on the inflation front, the Fed remains cautious, wanting inflation to trend toward its 2% target before any major rate reductions can be implemented. 

The delicate balancing act has left investors on edge, as seen with a spike in volatility as we near the end of summer. Is Wall Street heading for a crash, or will the economy continue to withstand these pressures? 

The Fed's Monetary Policy Reversion

Source: NYTimes

While the Fed has maintained the federal funds rate at 5.25%-5.5% in July 2024, after eight consecutive meetings without a change, there could be change coming. Inflation has eased to below 3% for the first time since 2021, and even though it is still slightly elevated, the Fed may choose to act early rather than late. 

Economic activity has continued to expand at a solid pace, and the labour market has shown signs of moderation, with job gains slowing and the unemployment rate edging higher. That clears a bit of room to change monetary policy to easing. 

Recent inflation data has set the stage for a rate cut in September. But is this because the economy is starting to get too weak? That could spell real damage for Wall Street, if economic conditions deteriorate faster than expected.

One rate cut of 0.25% won't change the equation for many borrowers and lenders, as there is mounting debt loads across the nation. If rates remain too high for too long, we could see something we've seen many times in the past, with a potential burst of the US credit bubble causing severe consequences for Wall Street if borrowing costs strain the economy too much. 

Investor Sentiment And Market Indicators

Investors are similarly concerned. The beginning of August saw major indices in the US suffer their worst three-day declines since 2022, with the NASDAQ falling 7.95% from July 31 to the end of August 05, 2024. 

Source: Investing.com

Those sharp declines have investors eyeing elevated levels of corporate debt and inflated asset prices, suggesting that the market may have a correction or even a larger downturn in store.  

Despite concerns, some experts maintain a more optimistic outlook. Maxim Manturov, head of investment research at Freedom24, acknowledges the risks but emphasises the importance of a balanced perspective: 

"Concerns about a potential stock market crash and bubble have a place. Nevertheless, it makes sense to maintain an optimistic view on the market based on both fundamentals, such as earnings growth, Fed rate cuts, and a booming technology sector, and other factors, especially in the longer term."

In a normal scenario, following typical S&P 500 cycles and demographic trends, we can expect the S&P 500 Index to rise significantly by the end of the decade. This forecast is based on continued earnings growth and market valuation ratio. Additional factors include earnings growth and expanding price-to-earnings (PE) ratios. While annual PE increases may seem ambitious, they are justified by the resilience demonstrated by businesses during the COVID-19 pandemic. Companies' ability to maintain profits despite severe economic shocks emphasises their resilience, guaranteeing a higher PE ratio than pre-pandemic levels."

Long-term Outlook: Optimism Amidst Uncertainty

There will always be concerns about market crashes, as the doom and gloom from financial reporting wants you to read their stories. But there are more compelling reasons to maintain a more optimistic long-term outlook. 

There is strong earnings growth across various sectors, especially in the technology industry. Not to mention, technological advancements in areas like artificial intelligence (AI) and machine learning continue to drive innovation and build on productivity, which means many companies will continue to thrive even in the face of some uncertain economic activity. 

Maxim Manturov highlighted this, as many companies were able to maintain or even boost profitability during periods of economic stress, like the COVID-19 pandemic. And while short-term market fluctuations can cause anxiety, it's more important to look at the underlying fundamentals long-term, which remain strong and look to grow significantly by the end of the decade. 

Conclusion

While there always seems to be a mixed outlook for investors, like the immediate risks from higher interest rates and inflated asset prices, there are always positives out there, too. Earnings and technological innovation have historically brought strong returns for Wall Street over the long-run. While market crash fears are not unfounded, remember the broader picture, where resilient companies and sectors continue to drive sustained market growth. 

Staying informed and adopting a balanced approach to your investments might be the best way to stick to it. Carefully weigh your risks and opportunities, as you, as an investor, want to get your plan in place with more confidence and even capitalize on growth opportunities amid short-term spikes in volatility.

On the date of publication, Dmytro Spilka did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer. Dmytro Spilka does not intend to make a trade in any of the securities mentioned above in the next 72 hours.