This Is Not The Time to Panic

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Stocks have been having a rough ride.  In the last few weeks, prices have fallen into negative territory for the year. Last week, the media tells us, market indices have had their worst week in a decade.  But before panicking or accepting the media’s parallels to the financial crisis of 2008-09, investors should keep these  considerations in mind:

  1. Unlike 2008, financial markets today function well.  Back then, people were afraid to trade with each other, much less engage in deal-making.  Today, trading in stocks and bonds happens smoothly.  Investment banks continue to underwrite new issues of stocks and bonds, and a variety of financial institutions are lending to individuals and businesses.
  2. The economy is growing. And it’s growing well, in fact, and faster than at any point in the last ten years.  In 2008-09, the economy was entering what came to be known as the “great recession”: unemployment skyrocketed and businesses failed.  There are no signs of a downturn today.  Indeed, the gross domestic product (GDP) for the third quarter (the most recent period for which we have data) grew in real terms at an annual rate of 3.4 percent.  Yes, housing sales and construction have slowed, but nothing like the 2008-09 collapse. On the contrary, the present slowdown reflects a well-ordered and reasonable response to the rising costs of property and mortgage financing.  While it is also true that, with unemployment at new lows and productive capacity utilization in industry on the high side, growth prospects face limits, but no constraints are imminent.

Against this background, the market would seem more likely to rise in the new year than fall.  To see why, consider four factors that have brought it down during these last few weeks:

  1. First is the Federal Reserve (Fed), which has been raising interest rates gradually for years and continued to do so through December. Late last month, policy makers indicated that they were nearly done with this project, but when they raised rates again in December, investors were disappointed. They were further concerned that the Fed indicated further moderate interest rate increases in the new year. Because these recent market losses have already discounted these future rate-hikes, it is unlikely that prices will suffer much, or at all, when the actual rate increases happen.
  2. Fears for the future of the US economy have emerged.  To some extent, they reflect the constraints on productive capacity just mentioned.  But these fears are premature––the effects of capacity restraints will take time before they begin to substantially affect the economy.
  3. Economic fears reflect the prospect of a trade war between the United States and China.  A trade war would indeed be grave and it would threaten markets, but it is unlikely to happen.  China especially needs a trade agreement.  Nor does the Trump administration, despite its bravado, really want a trade war.  The likelihood then is a mutual accommodation within the next few months that will soothe market concerns.
  4. Because prices are down, seasoned investors are harvesting losses in these last few weeks of the year order to write them off against longer-term gains on their taxes.  For the moment, such selling exaggerates the downward pressure on stock prices.  But because these investors will put their money back to work in the market in the new year (called the January effect by financial professionals), markets should see an immediate lift in the opening weeks of the new year or by February at the latest.

Of course, there are risks.  Efforts to avoid an unwanted (by both sides) trade war with China could nonetheless fail. The Fed could change its monetary policy.  Some new fear might emerge among emerging economies — or in Europe, where everything seems to be in flux.  But interpreting today’s picture, investor panic seems ill advised.  Panic selling would lock in losses and make it difficult for these sellers to buy stocks in time to catch the market’s likely future gains.  Even if the rebound fails to develop, little on the horizon suggests a continuation of recent steep declines.