This is no market meltdown
The stock market is crashing, so we’re told. And that’s a good thing.
Actually, the market isn’t crashing. It’s simply returning to normal. With any luck, we will soon be able to buy stocks at reasonable prices again.
For what seems like forever, we’ve had to pay ridiculous premiums for stocks trading far above their true value as indicated by underlying corporate earnings power, current and projected.
This is how bubbles burst, dramatically. At one point during Monday’s stunning drop in stock prices, the percentage collapse was the biggest on record, deeper than the Great Crash of 1929.
At the close of trading Monday, the S&P 500 was down 4.1 per cent, and the S&P/TSX composite index was off 1.7 per cent. Stock prices were down on every major bourse worldwide.
Several markets recovered somewhat on Tuesday. But the sell-off, which began in earnest about two weeks ago, will continue. Yet context is everything. Monday’s spectacular fall drove average stock prices down to a level not seen since . . . 2016.
A market tumble Friday presaged the Monday fallback. That decline, of 665 points in the Dow Jones Industrials — a drop of 2.5 per cent — ranks a mere 599th among the biggest one-day spills in the history of the markets.
The inevitable unwinding of the past decade’s irrational exuberance that is now underway is nothing like the market plunge of about 40 per cent at the outset of the Great Recession in 2008-09, only a decade ago.
Yet after that epic implosion, caused by the clear and present danger of a global credit crisis, the market soon recovered. It went on to set new stratospheric records — roughly 20 new record highs since January of last year alone.
Now an opposite phenomenon is in play. Market skeptics, or bears, expect the current rout to continue.
“The U.S. stock market is now around 25 per cent higher than it would have been had it grown at its historic average pace,” Ruchir Sharma, chief global strategist at Morgan Stanley Investment Management, wrote Monday in the New York Times.
Given that the market has so far retreated “only” 8 per cent, that leaves a lot of room for further decline.
Then again, there is no clear and present danger today.
The global economy is forecast to continue its impressive growth rate. Gains in wages and corporate profits have been strong across North America. Full employment prevails in most advanced economies. The Canadian jobless rate is at a 42-year low.
Anti-free-trade sentiment has peaked and begun to wane, promising an even more robust world economy.
The world has adjusted remarkably well to a Chinese powerhouse economy now growing at a sustain- able rate of 5 per cent or so, after a decade of annual double-digit GDP gains by the world’s second-largest economy.
And Silicon Valley-like hothouses of innovation paired with the venture capital to finance it are now evident in Vietnam and Eastern Europe; in Toronto; Melbourne; Boise, Idaho and elsewhere.
Indeed, the upside potential for the world economy is enormous.
The planet is beset with a multitude of armed conflicts, refugee crises and politically unstable regimes. A further strengthening in global GDP is to be expected if these crises are resolved, as at least some of them will be.
Anyone who claims authority on precisely why the market is dropping is wrong. Because the market is the collective, enigmatic sentiment of tens of millions of investors, it’s borderline folly to cite specific factors accounting for its behaviour.
For the record, investors are said to fear the rise in interest rates engineered by the world’s central banks, after a long stretch of easy money, which contributed mightily to the exuberance. The Bank of Canada has been in the vanguard, with several recent hikes in its key lending rate.
Traditionally, higher interest rates do exert downward pressure on stock prices, for two reasons.
An increase in the cost of capital raises the cost of doing business and of financing consumer purchases. That in turn cuts into corporate profits and has a taming effect on share prices that represent those profits.
Higher interest rates also draw investment away from the stock market, as interest-bearing investments become competitive with the return on equities. That is a rebalancing of the investment world that has been long overdue.
The current tightening in monetary policy began some time ago. But equity investors stubbornly refused to acknowledge it. Suddenly, starting last fall, the new reality set in, and the full manifestation of it is playing out now.
But don’t anyone call this a stock market meltdown.
You would think from panicky reports in many quarters that managers of $100-billion pension funds are poised to dump all of their stocks in favour of U.S. Treasuries.
What’s happening instead is that wise money managers are trimming (not eliminating) their stock holdings, and are bulking up on corporate and government bonds, mortgages and other interest-bearing securities now that they finally show signs of offering a decent return.
Stocks will offer better long-term returns, too, as equity prices ease. Which means that both household and institutional investment portfolios will soon have a more sensible balance of equities and interestbearing securities.
For years, the stock market has been characterized by too much money chasing too few worthwhile investments. The same phenomenon accounts for the booms in cryptocurrencies such as Bitcoin, selected real estate markets and marijuana stocks. Each of those asset classes is in the throes of a decompression, the air being let out of the balloon.
Strange as it may seem, with stock prices currently dropping, a market that has come down from the clouds will be a safer and more lucrative place in which to invest.
And obviously that’s a good thing. dolive@thestar.ca