Recently there has been what some investors believe are “corrections” to major stock markets. However, the reality is that these major corrections may instead be extreme turning points – the result of major economies, like America, trading long-term growth for short-term stability. As a result, we are now witnessing the consequences of massive stimulus spending, quantitative easing, and tapering (in America, the European Union, and Japan) in the form of extremely volatile markets. For this article, I will focus on the United States, and its monetary policies, in an attempt to understand and explain the realities we face.
The rollercoaster ride continues on Wall Street; after a tumultuous beginning to the new year, a beginning in which the Dow fell more than 5% in January, investors remain pessimistic of both developed and emerging markets. Spooked by weak U.S. earnings, increased Fed tapering, growing government intervention, and a stagnant jobs market, investors have triggered a massive sell-off that has led to a 1,200 point drop in the Dow. This, in turn with the Nikkei’s dismal performance and weak Chinese manufacturing numbers, has contributed to the economic woes of developing countries, such as India and Brazil (in addition to their already high inflation rates and deficits). Thus, this cyclical domino effect continues to push markets lower and uncertainty higher. So, are these massive drops a temporary correction to our markets, or are they a glimpse into the future?
Since the Great recession of 2008, America has steadily rebounded amid heavy stimulus spending and the Fed’s quantitative easing act. Such spending has forced interest rates down, which has, in turn, gradually increased consumer sentiment and purchasing power. These acts have proven effective over the past years and have helped the U.S. regain its footing – mainly because consumer spending accounts for 2/3 of U.S. GDP. In other words, John Maynard Keynes would be proud with the Obama administration’s policy choices, less the fact that Keynes promoted high government stimulus spending for short time periods (rampant U.S. stimulus spending has continued since 2008). Thus, the recovery has not come without costs to the American taxpayer.
Quantitative easing gained momentum during 2007, as evidence of a U.S. housing collapse emerged, and has since required roughly $85 billion per month to fund. To many it was clear that such spending couldn’t be sustained, but what other choices did the government realistically have? Not many. Thus the United States, via fiscal and monetary policies, funded a gradual economic recovery, and with it the re-emergence of America’s stock market.
With government programs like quantitative easing in place, investors pumped trillions into U.S. institutions because, in a sense, their investments were guaranteed; the U.S. government arguably mitigated the risk involved with investing, as its policies drove consumer interest rates to the zero bound limit. As a result, due to the prospects of increased consumer confidence, spending, and purchasing power, the stock market soared; companies that had been hemorrhaging money began to report record profits and the Dow more than doubled since the 2008 financial crisis (up from ~6,600 points to a high of 16,588 in five years). No doubt, this is phenomenal growth, but it is short-term growth that has been manipulated by government monetary policies.
Investors have finally opened their eyes for the first time in five years, and now realize the long-term economic repercussions of artificially inflated U.S. markets. When companies like Amazon and Facebook have P/E ratios of 590 and 95, and Twitter is valued at $37 billion, without having ever posted a profit, individual investors, hedge funds, and brokerage firms take notice. Thus we see trading periods dominated by sell-off runs, which leads to high volatility (measured by the Vix Volatility Index).
As of late the demand for equities has been outpaced by supply, and stock prices continue to drop. This fundamental economic concept, of supply and demand, can easily explain the recent downward spiral of American stock markets. Hopefully we see a rebound in the stock market, attributed to higher corporate earnings, and an increasing GDP; otherwise another U.S., and thus global, recession are on the horizon.