Market corrections come around, and they’re usually short-lived.

But when bear markets arrive, no matter how long they last, it always seems too long. It’s painful and uncomfortable, and it stresses everybody out.

A bear market usually comes about because there’s a problem – or series of problems – that needs to be fixed. This bear market is no exception.

And today, I’m going to outline the problems that are already being fixed… and direct our attention to two more that still need to be fixed before it’s smooth sailing again.

How We Got Here

In a prior essay, I’ve laid out the road map of how things have been going so far.

When the Fed made it easy to get access to “free” money following the COVID pandemic, much of that money chased asset prices higher to valuations that didn’t make sense.

So this year, we’ve seen overheated tech stocks and crypto finally tumble, while things like energy stocks have risen. We also saw the margin debt bubble pop amid all this for similar reasons.

That brings us to where we are now.

As uncomfortable as it has been, the problems caused by speculation in riskier assets and high margin debt needed to get fixed. This is inherently a good thing.

Yet the conversation has since refocused on what the Fed will do. So far, the Fed has raised rates to a target rate of around 1.50–1.75%.

But talk about inflation and interest rates has increased uncertainty about this bear market turning into a recession.

And as we likely know by now, the market hates uncertainty.

When there’s uncertainty, people lack the confidence to buy shares. And when there are fewer buyers, volatility rushes in. Until that uncertainty gets settled, markets struggle to find their footing.

It’s the same story for every bear market prior.

I’d like to tell you that I think we’re in the final innings… but there are still a couple more problems to solve first.

The first is a topic that might hit home for many Americans. That is consumer credit.

The Coming Correction

Not a lot of people are talking about consumer credit right now. But there’s a coming correction in consumer credit that must happen.

We’ve all become victims of surging inflation. We are all paying more at the pump and the grocery store. Yet not all of us are experiencing a wage increase to keep pace with that.

And given that most of America doesn’t have one month’s worth of liquid cash savings… How does one pay for this?

The answer, of course, has plagued America for decades: personal debt.

Credit card balances are surging. And a rising interest rate environment gives credit card companies and financing companies the freedom to jack up the interest rates on outstanding debt balances.

This was made even easier during the Trump administration when policy was enacted to remove limits on how much interest these companies can charge.

Of course, this is good news for the finance companies, as they get bigger margins to profit off of lending. The problem arises when consumers approach their maximum borrowing potential.

In simple terms, if a credit card has $5,000 of available credit and we’ve borrowed $4,000, we’re using 80% of the credit line. If this happened last year at an average rate of, say, 15% while consumer prices were normal, people could carry the step balance easily.

Yet if interest rates now rise to 20% or more while we’re being squeezed elsewhere from paying more for gas and food… the balance might go from $4,000 to $4,500. That person is now at 90% usage, and their credit score is likely to fall. This affects our ability to gain access to other credit lines too.

As the vice titans, eventually credit card companies start demanding payments or asking us to reduce our credit balances.

This is one of the final two shoes to drop for the American consumer.

Americans are being handed the bill now for the economic tightening from the COVID bailout. The average American bears the responsibility of the Fed’s actions to tighten the American economy so it didn’t spiral out of control.

That’s a tough burden to bear. In history, it’s not a burden for the rich. Their lives go relatively unaffected. It’s the average American blue-collar worker who is really feeling the pinch right now.

Consumer credit in the United States tops more than $4.5 trillion, so it’s plain to see that even a small disruption in interest rates or debt balances can have a very large impact overall.

And I expect more pain is coming in this arena in the months ahead…

The Last Puzzle Pieces

Despite the dire picture all this paints, I wouldn’t fear too much.

The credit card companies have been through this before, and they know exactly when to dial things back to sustain maximum profitability.

Historically speaking, higher interest rates are better for financial companies… as long as they don’t get too greedy and extend credit that they know consumers can’t repay.

I don’t think that’s going to happen here. But I do think consumer credit is one of the last two pieces of the puzzle to resolve in order to smooth the way our next bull run.

The other is housing costs… which I’ll discuss more about in an upcoming essay next week. Stay tuned for that…

Talk soon,

Jason Bodner
Editor, Outlier Insights