The gap between the economy and the stock market may be narrowing, as recent weeks have shown signs of change. I’ve written before about how the economy and the stock market often diverge — sometimes significantly. Inflation, for example, can drive up the value of large companies while at the same time putting strain on everyday people.
That’s why we’ve seen “melt-ups” in the market that defy logic to most observers. We saw this happen during the 2008 financial crisis, and we’ve seen it again recently.
However, with less stimulus money flowing into the system and inflation settling around neutral levels, we may be reaching an inflection point. The “chickens” of economic strain could finally come home to roost. While general macroeconomic reports have been overwhelmingly negative for weeks — honestly, for much longer — it hasn’t shaken the market yet. In fact, 2024 was a banner year for stocks.
So, what’s next? Will we see a continued melt-up? It’s possible.
With limited alternatives to equities — many people won’t settle for a 4% return in cash accounts — money keeps flowing into the market. But tipping points are inevitable, and in an overvalued stock market like this one, the risk is high.
What Could Trigger a Downturn?
There are several factors that could disrupt the current melt-up:
- Record-high property taxes and insurance now account for 32% of U.S. mortgage payments, threatening consumer spending.
- Stock-bond correlation has hit a record high of 0.73 over three years, undermining diversification strategies.
- The Federal Reserve’s $1.7 trillion in mortgage-backed securities purchases during a constrained housing market have fueled unsustainable prices.
- ISM data shows prices paid by purchasing managers at a 22-month high, raising inflation concerns.
- A major bond ETF, $TLT, has seen $7.4 billion in outflows over two months as investors retreat from long-term bonds.
- Tesla’s refreshed Model Y launch in China adds pressure in the competitive EV market.
- Home listings sitting unsold for 60+ days now account for 54.5% of the market, the longest slowdown since 2019.
- Construction job openings have fallen by 178,000 year-over-year, marking a near 20-year record decline.
Staying Nimble
So, what can we do in this environment?
For me, the answer lies in flexibility. Long-term trades may face significant challenges, so my focus has shifted to short-term strategies. Booking quick profits allows us to navigate potential bearish moves while remaining engaged in the market.
If you’re interested in adapting to this market environment, consider exploring strategies like Overnight Options. They can provide opportunities to capitalize on short-term moves while minimizing exposure to larger market risks.
Stay nimble and stay ahead.
Happy trading,
Nate
