Over the last 2 weeks the stock market has been on a wild ride, and for the most part a downward slope. Last week the Dow dropped for 6 straight days, including an 831-point drop which was the 3rd largest of the year, and the biggest since February.
Long ago we reported to you that the stock market had decoupled from the main economy. This occurred during the previous Administration in the wake of the 2008 financial crisis. Banks did not lend into businesses for the purpose of business expansion, but used government bailouts to trade bank stock and financial paper. This was great for the stock market – which continued to rise and allowed your 401K to rebound from the collapse.
But it was lousy for the economy – GDP grew at less than 2% for that 8 year period … wages remained stagnant … job growth was non-existent. The unemployment rate came down, but because more people went on government assistance in all forms, including disability, and stopped looking for work. Bottom line – instead of stock market gains from a new invention, a new drug, or increased demand, we instead had artificial inflation due to money printing and quantitative easing. The market had decoupled from main street.
Fast forward to the Trump Administration – tax reform and massive deregulation allowed the stock market to not just go up, but explode skyward! This was on the back of real GDP acceleration – main street was creating jobs again … wages expanded 2.8% – first time in a decade … businesses were expanding … this is real economic growth, the vibrancy of capitalism unleashed from government intervention.
All of those upward trend-lines are at risk, however, if non-market factors return as the dominant player, and that is happening as the Federal Reserve continues to raise interest rates, and hint there are more to come. It was that decision that prompted the most recent sell-off, and remains the primary concern of traders on Wall Street.
Our readers know the Fed raises rates when the economy appears to be overheating, or if the value of the dollar begins to significantly decline. Since we remained at zero interest rates for virtually the entire post-financial collapse period of 2009-2017, it was natural to begin to see the Fed move off their accommodating policy and begin to tighten the money supply. This began in the final year of the previous Administration.
This was a sign of a healthy and strengthening economy, and a normal process to undertake. Federal Reserve rate policy helped price the dollar at a stronger position, and despite raising the cost of borrowing, the economy continued to expand. This was the Trump-Bump effect!
But taking long-overdue steps to normalize rate policy does not mean the Federal reserve is making the right decision to continually raise rates in such short time span. It could derail the expanding economy as jittery business owners spooked by rising borrowing costs slow their hiring decisions and potential investment back into the business. Trump says the Fed is “loco” … here is why he may be right!
WHY TRUMP MAY BE RIGHT – LONG-SUPPORTED FED RATE HIKES MAY BE COMING IN TOO FAST FOR NOW:
1. “Fed’s dual mandate could cause both to get worse”: The Federal Reserve has a dual mandate – keep inflation in check and keep unemployment low. So monetary policy – and what the Fed does with interest rates – is to serve these two policy objectives. The problem is both are impacted and driven by a myriad of factors beyond just what the Fed does, and often times they are their own driver of particular outcomes in the economy. Raising rates to stem the tide of inflation can result in higher costs for government debt service … which in turns drives the government to borrow more money to service that debt … which in turn leads to a larger money supply… which in turn – you guessed it – drives up inflation. Inflationary pressure squeezes profits – and that squeezes wages and hiring. That also leads to greater unemployment.
2. “Fed rate increases have not hurt the economy – yet”: Markets remain elevated at record-setting levels and the US economy has been on over-drive during the last 2 years. The Fed has increased rates 8 times since December 2015 – taking us off zero and bringing the fed funds rate to 2.25% as of September of this year. This remains historically low – the federal reserve has typically maintained rates between 4 and 6% when experiencing expanding GDP. We have been in a government created expansion between 2009-17, and market driven expansion the last two years, but the rates have remained historically low. So increasing rates is bring them within the normal historical range.
Raising rates too quickly in such a volatile environment runs the risk of off-setting the gains of the last two years. 25 basis point is not a huge number, but the market is pricing in more rate hikes and higher rate increases thanks to commentary coming from the Fed. That lays the groundwork for a correction.
3. “The evidence confirms fed rate hikes are slowing housing and auto sales”: Despite an on-fire economy, sales in housing and autos were down year-over-year in the last quarter. These two data points are the “canaries in the coal mine” for potential negative downturns in the economy. The Fed right now has a direct hand in the potential negative shift in the market, and in the GDP numbers.
Despite some correction numbers occurring in the stock market over the last two weeks, the economy has been humming along. Decoupled from Wall Street, businesses no longer prioritize their stock broker when looking for funding. The market dip does affect balance sheets, portfolios and retirement accounts, and the raising of interest rates right now is beginning to take its toll.
Want protection from market downsides such as in the recent negative dip? Call now for protected principal alternatives. (877) 912-1919