8-16-19

Stock Market Movement

Stock market investors have experienced scary declines in market value over the past few weeks. This is a good example for the market volatility that we described in our news blast in June 2019. In this news blast, we will examine what caused the most recent drops in market value and what the consequences may be.
 
On Monday, July 29, 2019, the Dow Jones closing tick was 27,221 points. The world of a stock market investors seemed to be calm and quiet. A week later, on August 5, 2019, the picture already looked radically different. The Dow Jones closed on 25,717 points after a loss of 1,504 points or 5.5% of market value over the course of one week. On Monday, August 5, 2019 alone, the market plunged by 767 points, the sixth largest drop in history (at that time). Only 9 days later, on Wednesday, August 14, 2019, the Dow Jones dropped by stunning 800 points in one day. What had happened?
 
Causes for Market Instability
 
Let’s recap the events in chronological order. First, on July 31, 2019, the Federal Reserve lowered interest rates for the first time since the Financial Crisis in 2008 to help stave off the possibility of an economic downturn. The central bank is hoping a rate cut will be the necessary injection to keep the US economy healthy. However, with its move to cut interest rates, the Federal Reserve signaled a concern for the health of the US economy. Bad news scares investors. The stock market dropped as a result.
 
Second, on August 2, 2019, The White House said they will impose a fresh 10% tariff on another 300 billion dollars of Chinese goods, because the latest rounds of bilateral trade negotiations showed little signs of a breakthrough. This latest set of tariffs effectively taxes all Chinese imports into the US and represents a sharp escalation of a trade war between the US and China. Businesses and investors do not like trade wars, because they represent uncertainty and lead to a delay in investments. The stock market dropped as a result.
 
Next, on August 5, 2019, the Chinese government responded to the latest round of tariffs by allowing the Yuan, its national currency, to drop below the threshold ratio of 7 to 1 against the US dollar. The last time it reached this level, was during the financial crisis in 2008. This defensive measure allows Chinese exports to be cheaper for US buyers, partially offsetting the effects US tariffs. Of course, the Chinese government denies the fact that this is a competitive devaluation. But to neutral observers, the timing of the devaluation suggests that a possible trade war will be accompanied by a currency war. Capricious currency movements are the opposite of certainty and investors were surprised. The stock market dropped as a result.
 
Further, on August 14, 2019, the 10-year Treasury bond yield fell below 1.6%, dropping below the yield of 2-year bonds - for the first this since 2007. Ten days earlier, the 10-year bond yield had already fallen below the 3-year bond yield. This inversion of yields between long-term and short-term bonds has been a reliable harbinger for the prediction of a recession in the past. In a healthy market environment investors require a higher premium to invest in long-term bonds, because the expectation is that better investment opportunities are likely to arise in the near future. In an unhealthy market environment this picture reverses. Now investors look to long-term bonds as a safe harbor for their investments, thus driving down the yield of long-term bonds. Since the 10-year yield fell below the 2-year yield, many investors became scarred of a possible recession. The stock market dropped as a result. 
 
 
Possible Consequences
 
Three scenarios seem likely in the coming months. First, the market will continue to be volatile with sharp declines followed by soft recoveries, which especially depends on political developments between the US and China. A swift resolve of the trade war, could return stability and confidence back into the market. Second, we could see a market correction, similar to the 2018 Christmas stock shock, when stock values decreased significantly in a short period of time. This could be triggered by a bad round of quarterly earnings along with a troubled economic outlook for businesses. Lastly, there is a remote chance that an all-out crisis, similar to the financial crisis of 2008 might occur.
 
 
As an investor, it is your choice whether you invest your money into the stock market, given the current developments, or you select a safer alternative. There are more stable asset classes to choose from.