A Sane Response to Market Panics

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Stocks have panicked twice during the last few weeks. The first downdraft came on Monday, August 12 on the news that China had allowed its currency, the Yuan, to fall sharply against the dollar.  The Dow Jones Industrial average fell some 400 points that day.  All day, people asked each other, “Is this the big turn?” In the days following, the market recovered the lost ground.  On the following Wednesday, August 14, the Dow Index crashed again  –– an even more dramatic 800 points –– on news that, first, already weak European economies might actually have shrunk slightly and, second, on renewed awareness that long-term bond yields had fallen below short-term note yields in what is termed a yield curve inversion and which is a classic sign of an impending recession.  But before the week was out, markets had all but recovered that lost ground.

There is a lesson here about the largely emotional behavior of investors and pricing stocks on a day-to-day rather than a fundamental basis.  Actually, there are at least four lessons:

  1. Headlines intend to inflame readers, and fear is the ultimate clickbait. China, in allowing the Yuan to lose value against the dollar, was not, as was so frequently described during that panicked day, a sign of resolve or a trump card (no pun intended) played in its trade war with the United States.  A little reflection, which was something investors did in subsequent days, revealed that Beijing’s gesture was more a sign of weakness than anything else.  It showed that China could not successfully match the United States tariff-for-tariff, as it had earlier in this conflict.  In the teeth of that Monday panic, if investors had just waited for the market close to think about reality instead of giving in to fear, they might have used the retreat as an immediate buying opportunity, or simply saved themselves needless anxiety.
  2. There are no foolproof indicators. During the second panic, many guests on CNBC and other financial news outlets spoke of the wonderful forecasting record of yield curve inversions.  No one used the word “foolproof,” but it was all but implied. If, however, the yield curve indicator is really as good as people said that day, we would all be billionaires, because market forecasting would be as easy as, let’s say, falling off a log. Since everyone is not yet a billionaire, we all have reason to doubt the claims that commentators made for the yield curve that afternoon.  Further, if yield inversions were really that reliable, the market would have long since fallen, because the curve had moved in and out of inversion since May of this year, when I first wrote on the subject and itemized how many times the yield curve has given false signals.  I’m not saying that people should ignore yield curve indicators.  On the contrary, investors should pay close attention and look for corroborating evidence, but panic should have no role in that effort.
  3. Markets, especially in the short run, feed on themselves. Not all sale decisions reflect a careful consideration of the fundamentals.  Program trading often relies on algorithms that use recent trends to forecast the next few hours.  When markets fall dramatically, for whatever reason, these asset managers sell, adding momentum to the down move.  (They can do the same on the way up.)  Adding more impetus to any downward momentum are sellers who had bought on margin (credit), and who must often sell into a sudden price drop to avoid a margin call that would force them to put up more money to support their position.
  4. It was not new news that European economies were weak, as was Japan’s. This information is valuable and it suggests that the U.S. recovery will increasingly face headwinds, unless these foreign economies pick up.  But that warning is an alert, and not a sign to panic, especially because the news is rather old. 

So, shut off the TV if necessary.  The way to deal with such events is to wait for the close of trading. Weigh what news there is –– if it really is news –– against the flow of information from the last few weeks and months. Only after you have done this review should you decide if your long-term plan (stressed so frequently in these posts that a hyperlink would go on for several lines) warrants action.  Perhaps, if that basic plan calls for you to commit idle cash, you might use the downslide as a buying opportunity, not to time market ups and downs, but to do what you needed and planned to do anyway, when the time was opportune.

 

The National Debt

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Several readers have asked why the market and just about everyone in authority in government and in business seem so unperturbed by the announcement that the federal government is now some $22 trillion in debt.  One reader, who describes himself as “just another working slob with credit card debt,” adds a little humor and sarcasm to the question:

“For my entire adult life I’ve been listening to Republicans and ‘brilliant’ business mavens warning us: THE NATIONAL DEBT! THE NATIONAL DEBT!  Now they are as silent as mice behind the national wallboard.  I myself lose sleep if my Amex bill is one day late. And here’s the market, climbing to historic highs, as if the national debt was nothing more than some spilled Saltine crumbs on the floor.  What gives???!!!

Good question!   Actually, he asks two questions: one about the hypocrisy of politicians and business people who complain inconsistently about the evils of debt; the other about the size of the debt outstanding and implicitly what it might mean for the economy and its financial markets.

As to the first question, it is only fair to note that the hypocrisy goes beyond Republicans and business people.  It is all but universal.  Republicans and business people say little about the national debt when the latest additions to it come from their own policies –– in this case tax cuts.  In the past, Democrats have decried Republican-based debt, even as they have ignored their own contributions to it.  The only reason Democrats are not pointing at the red ink this time is because their agenda would likewise involve huge additions to debt.  This time, they are arguing not against debt per se but that the increase in debt is in service of the wrong cause.  Republicans and Democrats, always and ever, have sought to further their own interest –– or rather those of their constituents.  Each has used the outcry over debt to discredit the other.

Having pointed this out, it would be useful now to gain some perspective on this huge number.  Twenty-two trillion dollars would certainly make for a daunting Amex bill. It’s a sum that goes beyond what any individual could comprehend, much less deal with.  But, of course, the $22 trillion debt does not belong to any one individual.  It belongs to the entire nation, and our nation has considerable resources.  The $22 trillion differs only a little from the income the United States produces every year.  The country’s gross domestic product (GDP) in 2019 seems set to come in at a little over $21 trillion.  The federal government seems set to take in revenues this year of $3.4 trillion. Theoretically, then, the U.S. –– meaning all of us as a nation (but not the government coffers)––could just about pay off the entire $22 trillion debt in one year if we directed our entire income—the gross national product — to that one purpose.  Similarly, Washington — the U.S. Treasury — would take about 6.5 years to pay it down if it spent the money on nothing else.

Of course, neither the nation nor its government would do such a thing.  Each has other obligations.   But the size of the resources against which the $22 trillion debt stands does take some of the fear out of that otherwise immense figure.  To make it more personal, it might help to think of these relationships as a family that carries a mortgage on its home equal to 5 to 6 times the family’s annual income.  The household can’t dedicate all its income to pay down the debt quickly, much as it would like to, because it has to eat and clothe itself, among other things. But the circumstance of a mortgage of that relative size is hardly uncommon and hardly draws squeals of outrage when it becomes known.

In one respect, the $22 trillion is even less outrageous than the family with the heavy mortgage.  Unlike the family, the government never has to pay off its debt. As individuals who have obligated themselves to pay off the mortgage approach the end of their lifespan, creditors will refuse to lend them money, and they will have to pay down the debt they already have.  But presumably, the country never dies.  As debt comes due, the government can borrow anew and use the new funds to pay off the maturing debt.  It has been doing this for decades, centuries actually.  Because the U.S. keeps growing and thereby expanding the resources available to its government, Washington can always get credit to retire old debt and even expand the amount outstanding.  The huge debts run up to fight World War II, for instance, amounted to 130 percent of the country’s GDP at the close of hostilities, relatively a lot higher than today’s figure.  It all came due in the 20 to 30 years after the war’s end.  Washington paid it off with newly borrowed funds.  It could get the funds because its lenders, mostly the American public and a few foreign governments, could envision America’s continuing economic growth generating the resources necessary to shoulder the new debt.

Problems arise when the growth of debt outstrips the perceived expansion of the resources behind it.  In this situation, creditors would become reluctant to lend, and Washington, instead of continuing to “roll the debt forward,” would then have to repay it.  This is similar to the different borrowing power and inclinations of companies that are growing fast or slowing down. Lenders eagerly line up for a company that is growing at, say, 10 percent a year or better, concluding that such growth makes it easier for management to pay off the debt.  Because the borrowing presumably enables the company to invest the borrowed funds and thus secure continued rapid growth, it makes sense for management to borrow — indeed, a reluctance to borrow would run counter to the company’s interests.  But the opposite is true for a company that is growing slowly.

This is hardly a complete picture of what is an indisputably complex matter, and it in no way suggests that debt is a good thing.  But it may help explain why the market and so many others have resisted the hysteria in the headlines.  They believe — rightly or wrongly — that the tax cuts that have added to the national debt will sustain the country’s necessary growth.