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Will a Nuclear Bomb Trigger the Next Stock Market Correction?

There’s an old saying on Wall Street: “Buy on the rumor, sell on the news,” implying that reality often falls short of fantasy.

However, this summer the stock market likes the economic news it’s seeing and instead of selling off, it’s racing higher to record territory. On August 2, the Dow Jones Industrial Average closed above 22,000 for the first time ever, while the broad-based S&P 500 and tech-heavy NASDAQ Composite Index also hit record highs in recent weeks.

It’s easy to understand why. The July employment report couldn’t have been much stronger. The 209,000 gain in total non-farm payroll jobs (compared to 183,000 expected) combined with a 4.3% unemployment rate leaves little room for improvement. Inflation also is low and didn’t increase at all in June, after rising only 0.1% in May. The Consumer Price Index (CPI) has increased 1.6% during the past 12 months, a third less than the 2.7% annual growth rate it posted just six months ago.

That puts the Federal Reserve in a difficult position. Should it raise rates to stave off potential inflation stoked by rising employment and escalating asset values, or leave rates unchanged since inflation appears to be under control? Higher interest rates would drive up borrowing costs, hurting the construction and automobile industries that rely heavily on debt to finance purchases.

Consumer advocacy groups complain that home ownership is unattainable for many Americans, yet new home sales in June of this year were 9.1% higher than in June 2016 and 50% greater than they were five years ago.

The problem with a “Goldilocks” economy like this one, where everything seems just right, is that no matter which way you turn the outcome is most likely less desirable than what you already have. Inflation can’t get much lower, employment can’t get much stronger, and asset values are higher than they’ve ever been. In this type of idyllic environment, the old adage “no news is good news” seems to be the safest way forward.

There will always be more news, both good and bad, as evidenced by this week’s escalating tensions between the U.S. and North Korea. Hopefully, the two sides can resolve their differences without resorting to war. But if they cannot, then the financial markets will surely react to the possibility of a regional conflict including China, Japan, South Korea and Russia. 

A quick look at the VIX, or volatility index that measures fear in the stock market, shows a sudden spike from a “nothing interesting is going on here” reading below 10 two days ago to an “okay, now I’m beginning to get worried” level above 14 on Thursday, revealing the degree to which a single news event can roil the markets.

Over the past couple of months, I have been predicting a stock market correction for later this year but was unsure of what would trigger it. It remains to be seen if the North Korea conflict turns out to be that thing, but if it is then you may not have much time to take action to protect your portfolio. If you’re not sure what to do, read our “Crash Protection Package” special report to see what stocks you should own if bad news sends the stock market reeling.

 

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