“The good news is bad news.” Donald Selkin, Newbridge Securities
Wages have been down since the Great Recession, but they are finally starting to recover. Americans who were only able to find part-time work are moving to full-time jobs and the economy is growing faster than at any time during the past decade. The Federal Reserve Board’s goal of increasing inflation is also being achieved after years of trying.
So, given all of the good economic news, why did the Dow Jones Industrial Average drop 1,175 points – its largest single-day point decline ever – on Feb. 5? And why, after recovering some of the loss, did it plunge again by more than 1,000 points a few days later?
One big reason is that, thanks to former Fed Chair Ben Bernanke’s grand experiment, markets have been unable to break the grip of the Federal Reserve Board. Because of that, today’s markets are like Bizarro world (aka, Htrae) from Superman comics, a place where down is up, up is down, hello means goodbye and goodbye means hello.
We’ve noted the backwards-is-forwards relationship between the markets and the economy during the years of quantitative easing, but hoped that the market had returned to being influenced by fundamentals. No such luck. The ghost of Ben Bernanke apparently continues to haunt us.
During President Obama’s two terms, the Fed used quantitative easing to manipulate the stock market and stock prices soared whenever there was bad economic news. That’s because bad news meant the Fed would buy even more bonds and bring interest rates even lower. Investors poured more money into stocks, because prices became more attractive relative to other assets. And as investors poured more money in, the stock market rose higher still.
While bonds historically had a negative correlation with stocks, they moved in the same direction, as did most other assets.
That was fine when it benefitted investors, even if wealthy investors benefited most, but what happens now if asset prices concurrently move in the opposite direction?
The recent good economic news caused investors to speculate that the Fed would likely hike interest rates faster than previously planned. The Fed has been boosting rates so slowly that, even though quantitative easing ended in 2014, the Fed fund interest rate has only increased from near zero to a range of 1.25% to 1.5%.
Concern about an overheating economy is also overheated. Tax reform and deregulation are also helping the economy regain its mojo, but we still have not had a full year of growth above 3%. Gross domestic product (GDP) grew 2.3% in 2017, with two consecutive quarters of 3.0+% growth, but growth cooled to 2.6% in the fourth quarter, according to the U.S. Bureau of Economic Analysis. The average growth rate between World War II and the Great Recession was 3.3%.
So, regardless of that record Dow drop, don’t panic. We’ll explain why tomorrow.