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Whole Lotta Shakin’ Goin’ On!!




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The author of this entry is responsible for this content, which is not edited by the Wilson County News or wilsoncountynews.com.
Dr. M. Ray Perryman
August 27, 2015 | 2,483 views | Post a comment

The past few days have been difficult for US equity markets and anyone who invests in, works with, or watches them. In a matter of minutes one day, the Dow Jones Industrial Average fell by 1000 points (though it recovered somewhat before the close); the average is now thousands of points off of its recent peak earlier this summer (though that could have changed by the time you’re reading this given volatility in the market and the fact that is up over 600 points for the day as I am writing). The tech-heavy NASDAQ and other major indices are likewise down. During one day, Apple stock alone was responsible for a $96 billion swing in value. There have also been significant gains, at least one of which persisted most of the day and then was totally wiped out by a 600 point plunge in the last hour. The underlying economics can shed some light on these gyrations and likely future directions, although gyrations of this magnitude are indicative of a lot of uncertainty.

While these declines are unpleasant, they are nowhere near what we saw in 2008 during the financial crisis. The 588.40 point drop in the Dow on August 24 ranked eighth highest in terms of the number of points. However, in percentage terms, it was 3.57%, and there are many days with larger declines on that basis. The original “Black Monday” in August 1987 saw a 22.6% drop in the Dow in a single day, which was far worse than even what happened in 1929.

Comparing the recent losses to 2008, it is rapidly apparent that the current drop is far milder. Four of the worst days for the Dow ever were during the fall of 2008: the worst ever 777.68 point drop September 29, second worst -733.08 on October 15, as well as the fourth and fifth worst on December 1 and October 9 (-679.95 and -678.92, respectively).

Large price swings are disconcerting, but volatility is just part of the deal in modern equity markets. In fact, there are a number of reasons for volatility to increase over time. Although in theory share prices reflect the underlying potential of a firm to make money (which usually doesn’t change all that rapidly), there are also market forces at work. Automated trading programs analyze information from a variety of sources and initiate stock trades without human intervention. A flurry of trades can trigger algorithms watching for such action or a specified change in prices, setting off still more trades. Normal market movements can thus be exaggerated, contributing to the amplitude of the swings. At the risk of being too philosophical, even the Second Law of Thermodynamics suggests that more mature markets with more timely access to information will experience less stability.

The catalyst for the recent declines has primarily been China and the situation with its economy and stock market. Due to its size, the state of the Chinese economy affects global conditions. As it becomes somewhat clear that growth there is slowing, concerns arise. Add to that a sharp drop in the Chinese stock market, and those concerns escalate. Chinese policymakers have been attempting to deal with situations that must be corrected (such as debt, a bubble in the stock market earlier this year, real estate imbalances, and currency exchange issues), and policies have caused some disruptions. Even so, I continue to think that the most likely outcome is slower growth in the Chinese economy than in the past, but still overall expansion at a healthy, sustainable rate.

China is a major trading partner for the United States (and for Texas), but some analysts are beginning to espouse the view that the reaction to the Chinese situation has been overblown. After all, the Chinese stock market is still down only slightly for the year and is well above where it stood 12 months ago (as we go to press), with the recent sharp declines due more to the puncturing of a bubble than anything else. While the situation could change or we could get better information regarding the extent of the problems in China, I do think there is some validity to the thought that we may be seeing some overreaction.

A more valid point which I have seen discussed is that there are fewer options available if another global financial or economic crisis ensues. Since 2008, there have been trillions injected into the US economy through stimulus packages and monetary policy moves to increase liquidity by the Federal Reserve. Interest rates have been driven down about as far as they can go. If a crisis threatens, we’ve already used up some of the first line responses. However, even with the situations in China and Greece and elsewhere around the world, a crisis of global proportions seems unlikely at present.

The fact is that there has actually been quite a bit of good news about the US economy. The most recent jobs reports have shown solid employment gains. Orders for durable goods rose more than expected in July, a good sign for the manufacturing sector. Lower oil prices improve profitability across a spectrum of industries and are on balance a positive for the US economy (though not for Texas as a major oil-producing state). Consumer sentiment is also up, and new home sales rose in July. In fact, at least some of the market decline is part of the tacit conversation between Wall Street and the Federal Reserve in which the investors try to postpone interest rate increases.

There are certainly risks to global and US economic performance. Investors are wary, and markets are reflecting their edginess. Unless things shift significantly, however, I am not anticipating a dramatic decline. The fundamental state of the US economy is just too solid, and over time the share prices of American companies will reflect that fact.

Dr. M. Ray Perryman is President and Chief Executive Officer of The Perryman Group (www.perrymangroup.com). He also serves as Institute Distinguished Professor of Economic Theory and Method at the International Institute for Advanced Studies.
 
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