Looking for Stock-Market Correction Culprits In All the Wrong Places
The recent correction in the stock market understandably has investors worried, and searching for answers. While it's folly to presume to understand the infinite thoughts and actions that influence market prices, it's fairly easy to at least dismiss the most common ones presently being offered up.
Most of the alleged sleuthing into the market's malaise has centered on fears about Fed tightening, presumed economic weakness in China, and a rapidly falling oil price that supposedly signals a recession. None stand up to the most basic of scrutiny.
Considering the Fed, numerous pieces of market commentary tie the present terror to the Fed's recent decision to hike the interbank lending rate 25 basis points. Worse (if this narrative is to be believed) is that the Fed's not done; thus scaring investors even more.
Many opinion pieces and books could be written debunking what is so plainly flawed, but with brevity in mind it should be said that the Fed's relevance is rapidly shrinking. It interacts with banks when it tries to influence the direction of credit, but banks account for a rapidly shrinking amount of the total lending pie. Missed all too often by Fed supporters and critics alike is that the central bank can't create credit (credit is real economic resources - trucks, tractors, computer, labor, etc.) as much as it can influence where some credit migrates toward through its interactions with banks. With the economic relevance of banks shrinking so is the Fed's.
And since the Fed quite simply cannot create credit despite what its critics and supporters believe, its rate machinations can't in any reasonable way increase or shrink its availability. If it could actually increase credit, every country in the world would have central banks actively increasing "credit." Good luck there. The Fed can once again only influence where some resources (credit) go, as opposed to limiting access to those same resources. In that certain sense a Fed "tightening" in no way means less credit. Market actors create the latter, and it doesn't sit idle based on the Fed's expressed desires.
Lastly on the Fed, it has long telegraphed further "tightening" as is. As such, markets have been pricing increased Fed activity for quite some time. A tiny Fed hike could in no way have surprised investors, and market corrections are always driven by surprise. If readers still aren't convinced, they need only think about Japan. The Bank of Japan has been "easy" since the late 1980s at least, but Japan's major stock-market index is still half of what it was in the late ‘80s. Central banks - and this includes the Fed - cannot decree market rallies.
Thinking more about Japan, its powerful, positive and tight trading relationship with the U.S. is well documented. Japan was China before China's people were happily allowed to shed communism in favor of the profit motive. This is important to remember in light of commentary suggesting that the U.S. economy and stock market have caught China's alleged cold. If so, how then would readers explain the mother of all bull markets that took place in 1990s U.S. alongside Japan's market and economic slide?
After that, it's amazing to witness all the downcast commentary about China itself. To read supposedly wise minds commenting on it, by next year China's economy will be half the size of today's. And despite the jaw-dropping absurdity of numbers like GDP, some are saying that per their "calculations" China's economy was never growing much as it was. Apparently it was all a dream? To believe the latter amounts to willful blindness. To visit China's various cities is to witness staggering growth occurring in frenzied fashion. The Chinese are in a hurry, and this matters when we consider that markets are always pricing in the future. To believe the pessimists, we'd have to believe that investors think the Chinese have out of the blue grown bored with this "silly" thing called work such that the economy is set to substantially contract It's not a serious view.
All of which brings us to the falling oil price. There's been lots of commentary suggesting that cheap oil has growth-obsessed U.S. investors running scared. One op-ed from a Keynesian analyst said that the falling oil price essentially is the recession. Not really. As Leif Wenar pointed out in last Saturday's Wall Street Journal, "more than half of the world's traded oil is stolen goods." What this tells us is that oil and its extraction is increasingly the stuff of backwards nations like Iran, Venezuela and Equatorial Guinea. To suggest as some do that market weakness is tied to a scenario whereby limited resources migrate toward what is advanced (technology), and away from what has always been plentiful (oil) and more modernly sold by the corrupt (oil) is just silly. The rush into oil, like the one that occurred in the 1970s, was a lurch backward for the U.S. into yesterday's economy. A blast away from the past could hardly be spooking investors other than those with heavy exposure to U.S. energy.
Furthermore, it can't be forgotten that oil slumped in the ‘80s and ‘90s after booming in the 1970s. Stock markets soared in the ‘80s and ‘90s, but stagnated in the ‘70s and 2000s when oil was hot. The reason why is obvious. Oil has never been scarce. It's only become expensive during periods of intense dollar weakness. Investors are always and and everywhere buying future dollar income streams when they invest. so it's no surprise that stocks do best when oil does the least well. That is so because the oil industry in the U.S. generally thrives the most when the dollar is weakest. What's bad for oil is great for stocks. Figure oil's correction began in the fall of 2014, but stocks soared. There's no ‘there' to the weak oil/weak stock market correlation.
And then let's not forget that an economy is but a collection of individuals. Are individuals worse off when the dollars they earn aren't being eviscerated by the U.S. Treasury? Are they worse off when gasoline costs them quite a bit less? Were Americans in breadlines during the ‘80s and ‘90s when a strong dollar crushed oil such that backwards countries supplied us with greater amounts of the energy we consumed?
All of which brings us to more realistic sources of market malaise. Stock markets are price machines. Buyers and sellers are constantly expressing their bullish and bearish views on the way to price discovery. In that case what's already known is never the source of major market moves. What's known is priced. The previously mentioned correction culprits promoted by the commentariat were already known. Surprise is what moves markets sharply.
Searching for surprises, probably the biggest ongoing one has been the strength of Donald Trump in the polls. More than a few (including this writer) have regularly predicted doom for the New York businessman, yet polling data continue to signal immense popularity for Trump. In last Friday's Wall Street Journal it was reported that "Donald Trump has opened a double-digit lead over his next closest Republican rival."
All this scares investors simply because he's made slapping tariffs on China one of his signature campaign ideas. Barriers to trade shrink the value of paychecks, subsidize the weak at the expense of the strong, force greater numbers of workers into vocations that don't maximize their talent, plus they often result in retaliation that shrinks global markets for the companies in the country initiating the trade war in the first place. Is it any surprise that Trump's surge has U.S. and Chinese investors on edge? While a Trump win still seems unlikely, investors have to at least price in the possibility. Worse, Trump's top opponent (from a polling perspective) in Ted Cruz atually talks up his tax plan for it taxing Chinese goods trying to reach the United States. Investors have a reason to be scared, and the story doesn't end there.
As the Wall Street Journal's Kim Strassel wrote last Friday, "Polls this week show Bernie Sanders tying or beating Hillary Clinton in Iowa and New Hampshire. Put another way, a self-described socialist, a man who makes many think of their crazy uncle Bob, is beating a woman who spent eight years planning this run, who is swimming in money, and who oversees the most powerful political machine in operation." Another surprise? Yes.
Without defending Clinton's policies for even a second, her strong support from Wall Street signaled an eventual walk back of her various economic ideas. Clinton was seen as somewhat safe to some investors, and rather beatable to other market participants. But now investors have to price in at least the possibility of an unhinged socialist running against a confirmed protectionist. This is not the stuff of good markets that are always pricing in the future. Going back a few months, and realistically a few weeks, few expected either Trump, Sanders or both to have this kind of staying power. But they do. That's a surprise, and considering their frequently confused economic views (Trump saying that Japan and China have persistently devalued vs. the dollar on the way to trade gains was horrifying for being so totally wrong) stated with great gusto, it's the kind of surprise that presumably has investors a little worried.
What should perhaps give investors happy pause beyond the cleansing ways of market corrections is history. Indeed, despite the poll numbers of Trump and Sanders, the American electorate has never revealed a ballot box preference for socialists or mercentalists. Odds are they won't this time either. If so, a market hedging against a bigger November surprise will make up for gains lost.
Whatever the answer it seems folly amid a stronger dollar, falling commodities and gridlock in Washington to bet against the American economy. This is the stuff of booms, not recessions. Assuming the electorate gifts voters with a boring November election outcome, patient investors will be rewarded for not exiting amid the Trump/Sanders correction.