Searching for Meaning Behind the Stock-Market Decline
The stock market giveth; the stock market taketh away.
With Wednesday a federal holiday to honor former President George H.W. Bush, the U.S. stock market will be closed until Dec. 6. But there's no moratorium on wondering what the effects of Tuesday's dramatic market sell-off — almost 800 points on the Dow, or more than 3% — might be.
Here are some key questions and tentative answers.
Q. Does the stock market selloff signal a recession?
A. Maybe, but most investors and economists seem to think otherwise. Growth of the economy (gross domestic product, or GDP) has been strong, averaging nearly 4% at an annual rate over the last two quarters. That's higher than estimates of long-term growth potential of about 2% annually. The usual explanation for the stock sell-off is that investors were confused by the U.S.-China agreement to resume trade negotiations.
Q. So, will the Federal Reserve's main policy-making body (the Federal Open Market Committee, or FOMC) still raise interest rates when it meets later this month?
A. That seems to be the consensus. Since December 2015, the FOMC has raised short-term interest rates, then near zero, eight times, with another increase indicated for December. Stocks' big decline makes this harder, if only because it seems contradictory to raise rates when the stock market is falling. But, says economist Mark Zandi of Moody's Analytics, "Trump would have to actually declare war for the Fed not to raise rates." They're needed, Zandi says, to prevent the economy from overheating. At 3.7%, the unemployment rate is already lower than many economists consider "full employment."
Q. But won't the drop in stocks automatically curb the economy through the so-called "wealth effect" — consumers and investors spending more when they feel richer and spending less when they feel poorer?
A. This would probably require further stock market declines. True, Tuesday's plunge amounted to a paper loss of about $1 trillion, or about 3.4%, according to Wilshire Associates. But despite this loss, stocks remain roughly where they were at the beginning of 2018.
Q. What about the "yield curve" — a relationship between short-term and long-term interest rates?
A. Banks and other financial institutions make their money by borrowing short at lower rates and lending long at higher rates. When the yield curve is "inverted," meaning short rates exceed long rates, the process begins to break down. Although most rates aren't inverted yet, they're getting closer. In a memo to clients, Capital Economics — an advisory group — says the possibility justifies "our downbeat view of the prospects for the U.S. economy."
Q. So what's the bottom line?
A. Put everything together, and it's this: There's more uncertainty, greater risk of an economic slump and a greater threat to Donald Trump's approval ratings. But for the moment, the status quo prevails.