- S-Network Global Indexes
- Posted January 2, 2019
What's Goin' On?
What is going on in global financial markets? It seems like no one really knows.
The only thing everyone can agree on is that what is happening right now is downright scary. Markets seem to have grown schizophrenic this December. If the 650-point decline in the Dow Jones Industrial Average on Christmas Eve didn’t send chills down one’s spine, then the 1050-point rise on the day after Christmas certainly should have.
The Dow has lost 6.31% on the year. Fair enough, but on New Year’s Eve, it closed 13.05% off its high for the year, which was achieved on October 3. This downward trajectory, which accelerated in early December, had investors seriously spooked.
What makes this particular market correction so frightening is that, unlike in 2008, no single reason has yet been identified for causing the downturn. Clearly, there has been a shift in sentiment and the old canard about there being more sellers than buyers is certainly correct. But why?
The Fed Should Take a Backseat
Fed Chairman Jay Powell is following his well-documented hawkish views in pursuing a monetary policy that many, including President Trump, consider misguided. But after last Wednesday's quarter-point rate hike, he indicated only another half-point hike in 2019. Can rising interest rates alone have produced this kind of correction? It's barely plausible that an aggregate hike of 1.5% over a two-year span (2018 and 2019) could cause this type of devastation.
There are also other factors influencing US monetary policy. The Fed is shrinking its balance sheet, which had become bloated after years of quantitative easing. This exercise takes the "buyer of last resort" out of US bond markets. It comes at a time when the US Treasury is being called upon to finance tax cut-driven deficits of more than a trillion dollars a year into the foreseeable future.
As if exploding federal deficits were not enough, it should be noted that corporate debt stands at $9.1 trillion, hinting at the possibility of a bubble.
Furthermore, with full employment and above-average rates of economic growth, the early warning signs of inflation are just over the horizon, even though inflation has not yet clearly manifested itself in the real economy. In fact, the threat of inflation is belied by a relatively flat yield curve.
Whether or not it is a real concern at this point, inflation is a Fed hawk's true bogeyman. This certainly rings true for Fed Chairman Powell, who is a true hawk. He is such a hawk, in fact, that he readily expresses concern about "elevated asset prices" in real estate and — drum roll please — equities.
A World in Disarray
As if hawkish Fed policy weren't enough, the markets are grappling with the impacts of Trump's trade wars. Understanding the global interactions triggered by changes in US trade policy is like trying to untangle a bowl of spaghetti. It can be done, but it is a messy process.
There is, however, one certainty about trade wars— if a full-blown war were to erupt between the US and China and/or the EU, "Katie bar the door!" It is worth noting that this was the worst December for the stock market since 1931, a year after the passage of the protectionist Smoot-Hawley Tariff Act.
Trade issues may be the root cause of nascent slowdowns in many of the world's great economies, including China. But irrespective of trade, the Chinese economy has troubles of its own. It carries a debt burden built up through years of government subsidy that may well be unsustainable in the years ahead. Declining growth rates are already evident as government officials in Beijing try to transition the Chinese economy from export-led to consumer-driven.
To make matters worse, the lack of transparency in Chinese accounts makes accurate measurement impossible and cloaks China's economic past — and hence its future — under a shroud of uncertainty.
Trouble in the EU
Lack of confidence in the Chinese economy may pale in comparison to that in the EU, where a growing number of countries, including charter members like Italy and France, face mounting economic challenges. Italy's new government is hardly likely to accept austerity emanating from Berlin and impose hardship on its populace. Historically, Italians have had a casual relationship with debt.
Popular unrest has already reared its ugly head in France, where the government has tried to deal with intractable economic issues — so far without success.
The EU runs a very real risk of unravelling in the current environment. Brexit is shaping up to be a chaotic process, where no one is satisfied with any of the possible outcomes. A hard Brexit, scheduled to occur in March if a deal is not reached, would have dire consequences for both the UK and the continental European economies.
Looking beyond Brexit, economies on the periphery of the EU run the risk of devolving to levels of prosperity more consistent with emerging markets than developed ones, making it politically difficult to sustain the raft of regulatory restrictions coming from Brussels. Further market declines would most certainly impose more stress on the Euro in the years ahead.
Crash Test Dummies
Then, there are secular concerns. In case anyone has missed it, a full-blown tech crash has been underway since mid-summer and early fall — a nascent bear market of potentially epic proportion — with FAANG stocks in particular taking a beating.
As recently as October 3rd, Apple closed at $232 per share. It closed on New Year’s Eve at $157 — a 32% decline. Since mid-summer, Facebook has fallen 40%; Amazon, 26%; Netflix, 36%; and Alphabet, retaining at least some dignity, a modest 18%.
Each of these declines can be traced back to a different source that is specific to each company. For example, Apple faces declining iPhone sales, while Facebook has come under intense regulatory scrutiny.
One common thread runs through the bear market in tech, however: demand for technology may have hit a wall as markets approach saturation levels for both hardware and applications. Accordingly, the top-line growth rates of recent years may no longer be sustainable.
Nor is the crash confined to "big tech." As government weighs in on drug pricing, the biotech sector hasn't performed much better recently. Popular biotech indexes have declined over 20% since late September.
Of great concern in terms of the tech crash is that the increasingly bleak sentiment for stocks — which remains largely ethereal — will become hard fact at the start of the new year, when Americans see the very real impact of recent market turmoil on their 401(k)s. Similarly, many defined-benefit pension plans, which had found stability in lofty equity values, are likely to realize the extent to which they are underfunded.
The New Year
Tying together all of the many factors weighing on the stock market as 2019 unfolds is a marked erosion of confidence in all branches of the US government, especially the Executive Branch. With each passing day, our current Administration looks more and more like a reality show where actions are taken impetuously without proper consideration of their consequences.
Furthermore, the Administration seems to be more and more driven by base politics than by authentic policy concerns.
It seems that everything President Trump does makes the thick roiling cloud of uncertainty that overhangs the capital ever more threatening. Forgetting for a moment the merits of his policy choices, his implementation of policy is widely regarded as divisive and erratic. The President’s behavior undermines confidence on a scale not seen in American politics since the end of World War II.
Of even greater concern is that the Trump Administration seems determined to cast aside the core tenets of the world economic system — a US invention after all. Even those who find his reasons for doing so acceptable know for certain, however, that a sudden end to American economic hegemony is bad news for everyone.
As a result, the current state of American politics weighs heavily on market psychology.
The stock market is a leading economic indicator, a “Cassandra” that not only foretells the future, but influences it as well. It is using its powers of augury to tell us to proceed with caution, to be afraid.
Seldom do markets crash for multiple reasons. In 2008, everyone could observe the train wreck unfold in slow motion. Starting with trouble at Bear Stearns in mid-2007, even casual observers knew that a mortgage crisis was unfolding. In the current market, we are deprived of such certain culpability.
In all of this, there is still reason for optimism, because none of the problems facing the global economy today are as intractable as the 2008 mortgage crisis. The Fed, for example, could adopt a more accommodative posture. Equitable trade agreements could be reached with China and the EU. The Chinese and EU economies could adjust and resume growth on a sounder and more rational basis. And a realistic Brexit plan could be adopted.
Technology could find a bottom and then assume a more rational growth path. And the Trump Administration could suddenly find maturity and place policy ahead of politics.
At S-Network, we like to say, "The markets will recover from these or subsequently lower levels!"
Happy New Year!