The S&P 500 hit yet another record high yesterday, led by fabulous earnings momentum (FEMO). That puts the index closer to our year-end target of 8,250 and 10,000 by the end of the decade. The economy has been growing without a recession since the Great Financial Crisis, except for the two-month lockdown recession in 2020. Our Roaring 2020s scenario is in its seventh year. Lots has gone wrong since the start of the decade, yet here we are with real GDP and the S&P 500 at record highs.
What could possibly go wrong as we look toward the end of the decade and the beginning of the new one? Lots could go wrong, yet the economy and stock market are likely to continue to pass future stress tests over the remainder of the decade as they have since the start of the decade.
So, we continue to assign a subjective probability of 80% to our Roaring 2020s scenario. The remaining 20% includes events that could derail this happy scenario. To discipline our research, we update this worry list from time to time. Here is the latest:
(1) Geopolitics. The Middle East has been a geopolitical maelstrom at least since Biblical times. The latest conflict started on February 28, when the US and Israel attacked Iran. Most observers expected a short war. However, Iran is under the control of the Iranian Revolutionary Guard Corps, a terrorist organization that is hard to defeat with just an air bombing campaign. The combatants on both sides have de-escalated the conflict in recent months. However, navigation through the Strait of Hormuz remains challenging, and Iran still has a nuclear program. The US continues to blockade Iran's crude oil exports. A flare-up in the war could push oil prices to this year's high or higher since oil inventories are running low around the world (chart).
(2) Bond Vigilantes. The 2-year US Treasury yield remains about 75bps above the federal funds rate, signaling that the Fed should raise the federal funds rate soon (chart). Friday's weak jobs report hasn't altered the scenario embedded in the yield, suggesting that financial markets continue to believe that the labor market is at full employment, while inflation remains above the Fed's 2.0% target.
