What’s behind the U.S. stock market bust?
By Habib Siddiqui
In the last couple of
weeks, the Dow-Jones index bounced like a wild horse that’s out of control. It closed at 23,190 before closing on last
Friday, Feb. 9.
The seesaw day on the market came after the Asian and
European markets both closed in negative territory. Japan's Nikkei 225 fell 508
points, or 2.32 percent, to 21,382, and China's Shanghai composite sank 4.02
percent to 3,130. The Pan-European STOXX 600 was off 0.70 percent and Britain's
FTSE was down 34 points, or 0.49 percent.
The Dow
and S&P 500, which also soared to a record high of 2,872 on Jan. 26, have
both pulled back more than 10 percent in the past two weeks.
What’s wrong with the Wall
Street? Only a week ago the POTUS was boasting about how well the US economy
had been performing since he was elected outdoing all previous records. Little
did Trump realize that his boasting would burst on his own face so quickly, so
badly and ‘bigly’! [As financial analysts would remind us the meteoric rise and
devastating fall of the stock market had almost nothing to do with the POTUS.]
No one seems
to know where the stock market is heading and why it took such a
stomach-crunching nose-dive. According to Yousef Abbasi, global market strategist for JonesTrading,
the U.S. stock market has lost a whopping $3.1 trillion since the Dow hit a
record high of 26,616 on Jan. 26.
Some experts say that it
was more like a necessary correction needed against an unsustainable growth
that could not be explained away by the fundamentals. Others say that the topsy-turvy market was fueled by fear of
inflation on the horizon, including whether rising wages and an increase in the
number of jobs added to the economy will prompt the U.S. Federal Reserve to
accelerate a rise in interest rates.
One of the catalysts for
the recent selloff in the stock market was the report on Feb. 2 that average hourly earnings or wages had
increased by 2.9% over the past year. This was the largest gain since the Great
Recession, and it led to a lot of speculation that the Federal Reserve would
have to raise interest rates a little more than expected this year to make sure
that wages (and inflation) don’t go too high.
New York Federal Reserve
President Bill Dudley called the stock market drop "small potatoes". A
rise in bond yields combined with a fall in stock prices is a market adjustment
to stronger global economic growth and correlating expectations that the Federal Reserve will
continue to raise interest rates, he said.
As noted by some experts, these days financial firms use
computers programmed with complex sets of instructions known as algorithms. They
identify trading opportunities and then strike faster than any human could.
Algorithmic trading has become so ubiquitous that some
estimate well over half of all trading of the S&P 500 Index is done this
way.
Such automated trading almost certainly
accelerated the sell-off, which saw the Dow Jones Industrial Average
crashing 800 points in ten minutes on Monday, Feb. 5. "The explosive speed
of the fall ... that is done by machines," said Tom Stevenson, Investment
Director at Fidelity Personal Investing.
Most analysts, according to BBC, believe the market
tumble was prompted by a report on the US job market, released on Feb. 2, which
showed strong wage growth. But the decision to sell on that news may have been
made by robot traders.
US government bonds, or Treasuries, fell in value after
the US jobs report. Yields (the interest that bonds offer investors) rise as
prices fall. It's thought that robot traders were waiting for
that yield to hit 3% - a significant figure as it could prompt human investors
to switch out of shares into bonds.
According to Tiffany
Wilding, a Pimco economist focusing on the U.S, whose article appeared in the Market Watch, “While the data are noisy,
and it’s risky to draw conclusions from one set of reports, we believe they may
reflect some trends worth watching — chief among them rising capacity constraints
and growing inflationary pressures.”
She points to some other
factors behind the wild ride that are worth sharing here. (1) Real
productivity growth was surprisingly weak in the fourth quarter 2017
(down 0.1% from the prior quarter on a seasonally adjusted annual rate basis),
and unit labor costs accelerated to 2.0% despite some moderation in real
compensation growth. (2) The headline ISM
Manufacturing Index moderated less than expected due to slowing
supplier deliveries, while the production, new orders and employment indexes
each declined. Meanwhile, the prices paid index increased to the highest level
since 2011. (3) Labor market aggregate hours, which correlate with real
economic output, declined 0.42% month-over-month in January, while average
hourly earnings gained 0.3% month-over-month and rose 2.9% year-over-year — the
highest rate since 2009.
“These data come at a time
when unemployment is below various estimates of the non-accelerating inflation
rate of unemployment (NAIRU), broader measures of labor market underutilization
are close to pre-crisis levels and payroll growth appears to have peaked for
this cycle and is decelerating,” Wilding writes.
What is the takeaway from
all of this? According to Wilding, “The U.S. is starting to look more like an
economy that is in the later stages of its business cycle. Absent a pickup in
productivity growth, slowing payroll growth and rising economic capacity
constraints should coincide with a gradual deceleration in real economic
activity and building inflationary pressures. Along these lines, the weak labor
productivity report released last week may raise questions about whether and to
what extent productivity will rise over the coming year in response to fiscal
expansion.”
Stock market’s behavior are
known to mimic historical periods of accelerating inflation, slowing growth. While
a range of indicators show that U.S. economic activity accelerated in the
second half of 2017, the equity market deterioration is more in line with
historical behavior during periods of accelerating inflation and slowing
growth.
It is interesting to note
that while much blame has been put on the increase in hourly wage rate, which
is only 2.9 percent, wages are growing barely faster than the inflation rate.
In real terms (i.e., adjusted for inflation), through December wages were up
just 0.6% year-over-year, down from 2.4% in October 2015, and 3.2% in the
mid-1990s.
According to Rex Nutting of the Market Watch, higher wage
rates do not necessarily translate into inflation. Companies usually would
raise prices when the fixed and variable costs are higher, and if they can
afford to get away with it, but are usually forced to “eat” some or all of the
increased costs, usually in the form of lower profits.
He opines that higher wages
aren’t putting pressure on companies to raise prices. After all, unit labor
costs increased only 0.2% in 2017, one of the lowest gains ever recorded at
this point in an expansion. According to the Bureau of Labor Statistics’ employment
cost index, private-industry wages rose only 0.5% (after adjusting
for price changes) in the past year.
So, it is the fear of losing profit in stock funds and not
higher wages that may be at the core of why Dow tumbled.
As a matter of fact, U.S. workers have been losing bargaining
power for decades, and the result is income stagnation for almost everybody
except the fortunate few. Real median household incomes (adjusted for price
changes) and real median weekly wages have barely budged since 2000.
In the 50 years between 1950 and 2000, workers received about
62% of total national income as compensation, but, as profits surged in this
millennium, the workers’ share has fallen to around 56%. “That may not sound
like much of a change,” Nutting opines, “but the decline in bargaining power
means that workers have lost out on nearly $10 trillion in income over the past
17 years compared with what they would have received if their share of the
ever-growing pie had remained constant.”
“Higher wages are exactly what the economy needs to keep the
expansion going. Higher wages would lure more would-be workers back into the
labor force. Higher wages would give companies an incentive to invest more in
capital goods and services, which would in turn boost productivity and living
standards. Higher wages would let more families to reach their dreams,” Nutting
says.
If the investors care about growth of the American economy,
they ought to share the American pie with low wage earners by increasing their
wages fairly, and should not be freaked out with a 9-cent an hour wage raise. On
the other hand, if they let fear and robots to dictate and feed their greed
then, surely, they haven’t seen the worst yet.
Finally, on a more serious note, as long as we live in a world
of interest and paper money, away from dinar
(gold) and dirham (silver), sadly, when it can be printed at the whim of a
central bank or a government and not dictated by production of commodities, goods
and services that others require, inflation
will remain an untamed beast that would surely eat away our share of the pie.
Something to ponder about!
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