Monday, February 12, 2018
After the enormous, even unprecedented market corrections of the past week, serious financial analysts are pulling out the big guns in an attempt to explain what is going on with Wall Street. I heard one describe it like this: “Everybody’s freaking out.”
Wow—please don’t get so technical on me. Then again, maybe a freak-out is exactly what is happening. If that’s the case, how do those of us who choose not to freak out avoid doing so?
The markets of the past 50 years have been and will continue to be about one thing: growth. Companies whose earnings do not grow are penalized in the markets. Over the past 30 years, during which earnings growth hasn’t been stellar, market values have instead been driven by Federal Reserve-induced low interest rates leading to corporate share repurchase strategies and merger and acquisition activity. In the past 22 years, the number of publicly traded companies has fallen by 46 percent.
The single most logical explanation for the rapid run-up in the Dow Jones Industrial Average over the past year is, quite simply, the Trump promise of a tax cut enacted by Congress. Markets live on promises, and this was a big one. In fact, it’s already becoming known as the signature move by the current administration.
But promises have a way of not coming true. The tax cut, it appears, is settling into the investment world like last year’s hit action movie. It sold plenty of tickets back then, but we’ve changed a lot since the summer.
There is much more going on out there. Media reports claim that the markets are responding to renewed fears of inflation that will be met with additional interest rate increases by the Fed. The Fed, however, has been signaling rate increases for quite some time now, so it might be surprising that the markets would adjust that drastically to the recent changes in the 10-year treasury rate, which has grown by 35 basis points over the past year. Such a growth in interest rates should result in a market correction of about 6 percent, yet recently we have seen much more than that.
So let’s go back to the idea of growth. In spite of record low interest rates over the past 20 years, overall economic expansion has been lackluster at best. The media point to rising wage growth as the most recent fuel adding to inflationary fears. But real wage growth is still somewhat flat. What you see in the labor markets is a mix—some sectors in which wages are growing rapidly (e.g., jobs involving information technology coding skills) and others in which wages are flat or even falling (most of the unskilled labor markets).
What should the little invester do when a bleary-eyed floor trader says, “We’re all freaking out, man”?
Well, first thing: Don’t panic. If it looks like a freak-out, it probably is.
Steve Isberg is an associate professor of finance and economics in the University of Baltimore’s Merrick School of Business.
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