That buying on the dip idea yesterday doesn’t look so hot today.
Markets had another wild ride yesterday. The Wall Street Journal’s overview:
The Dow Jones Industrial Average and S&P 500 entered correction territory for the first time in two years on Thursday as worries about rising interest rates and newfound volatility continued to rattle the markets…
“We opened around the highest levels of the day and closed at the lows, and that’s telling us the sellers aren’t quite done yet,” said Jonathan Corpina, senior managing partner at broker-dealer Meridian Equity Partners…
Mr. Corpina said the pace of Thursday’s declines, at hundred-point intervals, seemed to be driven by large sell orders from institutional investors, as well as by algorithmic orders triggered after major indexes broke through certain levels.
The S&P 500 fell 100.66 points, or 3.8%, to 2581.00 and is now down more than 10% from its record close on Jan. 26.
The decay towards the close does not bode well for tomorrow. The S&P 500 and the NASDAQ lost 3.75% and 3.9%, respectively, in the last hour. But even after the recent swan dive, the S&P 500 is still 12.5% higher than it was a year ago.
Now that this decline has proven to be more than a one-day, algo-driven affair, commentators are looking harder for explanations, particularly since that will give them a rationale for What To Do Next. Bloomberg helpfully offers six interpretations.
But it may not be all that complicated. Despite the seeming strength of the market rally through January, the post-Trump boomlet had less confidence among investors than I can ever recall. Even in early 2007, with the Fed well along in implementing interest rate increases and cracks visible in the subprime market, analysts were complacent, saying the Fed had created a Goldilocks market and would do such a good job of managing interest rates so as to not unduly discomfit investors. By contrast, last year it was common for normally chipper or studiedly agnostic experts to say how overvalued the market was. And that’s before getting to the outsized role that buybacks have played in EPS gains over the last three years.
So most people who were paying attention knew there was a lot of air in stock prices. And with the large role algo trading now plays, when corrections finally arrive, they are likely to be more violent than in the past.
Given that the Fed lost its nerve during the taper tantrum of 2014, they may have been unduly optimistic that central banks would back off from rate increases if stock markets swooned. That may in the end prove to be the case, but there are reasons to think central banks won’t be as easily deterred in 2018.
The first is not to forget that the Fed is very uncomfortable with super low rates. Even though central bank officials would never admit it, my sense is that they recognize that the experiment with QE and other extraordinary policies has largely been a failure. The goosing of asset prices hasn’t translated into growth. It’s increased inequality, which is now increasingly recognized as an economic negative, and also is increasing political instability.
In addition, being at near zero policy rates gives the Fed nowhere to go in a crisis. Even though there has been plenty of academic debate about negative interest rates, for the most part, they’ve only been imposed on end customers indirectly, via fees putting them in the position of having it cost them to park money. In the US, it would be a third rail issue to have rates be enough in negative terrain so as to impose them directly on consumers. Plus the claim that it would lead consumers to spend more is barmy. Negative rates send a loud signal of deflationary expectations, which means spending later is better because goods will be cheaper. And savers deprived of safe interest income will batten down even more rather than deplete principal.
So the Fed has been eager to raise interest rates and has had a bias towards interpreting labor market data as telling the story that conditions are tightening so as to allow them to keep nudging interest rates higher. As we noted, the much-ballyhooed average wage gains of last week went overwhelmingly to managerial workers, not the schlubs. New job creation was until recently in part-time jobs, and even now, the full time jobs created have been mainly low wage. All you need to know about labor bargaining power is look at working conditions at Amazon, not just in its warehouses, but now at Whole Foods and even in its executive offices. Nevertheless, investors apparently didn’t like yet another new unemployment claims report coming in at below 300,000, as that was only going to stiffen Fed resolve.
Not only is the Fed reacting to more signs of life in the economy, but the world economy is having a phase of synchronized growth. That means no other major central bank is likely to start spiking the punch bowl.
Needless to say, investors have been nervously watching the rise in bond yields. As Bloomberg noted:
Pressure again came from the Treasury market, where another weak auction put gave bond bears ammunition, sending the 10-year yield to the highest in four years. Equity investors took bond signal to mean interest rates will push higher, denting earnings and consumer-spending power.
Treasuries did firm later in the day. Commentators also made much of the fact that bets against volatility, particularly using Cboe Volatility-related instruments like the soon to be shuttered XIV ETN, fed the market decline.
As of this hour, (4:00 AM), the Nikkei had closed its session down 2.54%, the FTSE is off 0.42%, bu Dow futures are up 151 points and the S&P 500 mini, 20.75 points. So the more sanguine mood may hold till the market opening.
Despite the speed of the correction, it’s hard to get worked up about it given that this correction has merely erased recent froth. As indicated at the top, most US stock market investors are still sitting on healthy gains over the past year. And even if the selling continues, there’s no evidence of an unwind of levered speculation that could blow back and damage critical payments systems players or lenders. If the stock market slide continues, however, it could dent Trump’s recently improved approval ratings. Interviews of Trump supporters suggest that one regularly cited reason for their backing is that they’ve seen big gains in their stock portfolios. Will they be as solidly behind him if they were to evaporate?