Market fluctuations can evoke a range of emotions, similar to the thrilling ups and downs of a roller coaster. Recent events, like the staggering back-to-back drops of nearly 1,000 points in the Dow Jones Industrial Average (DJIA), remind us of the unpredictability of stock markets. While navigating these tumultuous times can be challenging, there are, surprisingly, several benefits to experiencing a market sell-off.
First and foremost, enduring a sharp decline in the stock market can be frustrating, often provoking more dread than delight. Many would prefer a root canal to watching their investments plummet. However, there are certain positive aspects to these swift downturns that merit attention.
For instance, the days that follow a market correction often signal a period of healing and optimism. The remarkable 567-point rebound in the DJIA this past Tuesday served as a beacon of hope amid despair, bringing light to dark times and joy to those who had been feeling downcast. Even President Trump, acknowledging the limits of his influence over the market, expressed concern over the recent slide.
A market correction serves an essential purpose by reminding us of the grounded nature of reality rather than a constructed fantasy. It demonstrates that, despite the efforts of central planners, the market retains its ability to fluctuate. This crucial detail tends to be overlooked during turbulent times.
This stock market turmoil also highlights the consequences of Federal Reserve actions. The Fed’s strategies of rate hikes and quantitative tightening are indeed making their mark. After years of bolstering stock and credit markets, the Fed is now deliberately attempting to deflate them, an intricate and questionable game that central bankers are playing.
Struggling Markets
Central planners are constantly trying to anticipate and mold the future. But how can they ascertain what a ‘better’ future truly entails? Is it merely characterized by higher stock prices or a lower unemployment rate? Additionally, how can they guarantee that these changes come to fruition?
The pressure on central bankers mostly aims to ensure a predictably stable future for their member banks, allowing them to profit from borrowing short and lending long without fail. Taming credit markets is one of the many strategies they employ in their futile and detrimental efforts.
They may believe they can extend the growth phase of the business cycle, yet in doing so, they create a web of poor decisions, characterized by excessive debt and misallocated investments. This ultimately strains the economy and creates internal conflicts.
One complete truth is that the future is always cloaked in uncertainty. No individual can really predict what tomorrow holds – a universal reality of human existence. Attempts to control the future essentially lead to market distortions and imbalanced economies.
The narrative surrounding the nine-year bull market primarily tells the story of extreme intervention by central bankers. Institutions like the Federal Reserve, European Central Bank, Bank of Japan, and the People’s Bank of China have all engaged in numerous dubious actions in their quest to create a better future. Some central banks, particularly the Bank of Japan, have even conjured money out of thin air to purchase stocks.
Has this intense monetary policy produced a genuinely healthy market, or has it done the opposite? Dr. Daniel Cloud, a philosopher, provides a thought-provoking perspective in his work, The Lily:
“Planned markets are sick markets, markets that are always in crisis because their most important social function—facilitating selection between competing pools of capital based on real-world viability—has been disrupted by the planner’s clumsy interference. When the state attempts to plan a market, it inadvertently transforms savvy risk-takers into mindless followers, severely undermining their ability to gauge good investment opportunities.”
What Type of Stock Market Purge Are We Experiencing?
This week’s market chaos has revealed how the Fed’s interventions have fostered a multitude of mindless followers. These investors became entrapped in a fabricated world of predictability supported by the Fed’s excessive liquidity, mistakenly believing it would persist indefinitely. Years of misguided rewards for making poor decisions led to a warped market perspective.
Several months ago, in an article titled The Complete Idiot’s Guide for Being an Idiot, we outlined three common foolish behaviors. One such action included shorting the CBOE Volatility Index (VIX) when it was below 10. This past Monday, after years of seemingly effortless gains, shorting the VIX backfired dramatically.
One retail product aimed at shorting the VIX, the VelocityShares Daily Inverse VIX Short-Term exchange-traded note (with the ironically fitting ticker XIV), plummeted approximately 85 percent in after-hours trading on Monday and tumbled a staggering 93 percent on Tuesday. According to Credit Suisse, this product will be terminated on February 20.
From a broader viewpoint, the landscape has shifted drastically since the DJIA reached its peak of 26,616 on January 26—merely two weeks ago. The DJIA has since dropped over 10 percent, leaving the market feeling more precarious. Volatility has returned, with the 10-Year Treasury note yield surpassing 2.85 percent, and GDP growth may not be as robust as initially claimed.
What is still uncertain is the nature of this stock market purge. Could it mirror the dip from mid-2015 to early 2016, where the DJIA fell 12 percent before regaining momentum? Or does it resemble the period from late-2007 to early-2009, when the DJIA plummeted by 50 percent coinciding with the depths of the Great Recession?
In simpler terms, are we witnessing a common market correction, or is this the beginning of a severe bear market that could decimate portfolios and destabilize investment funds?
Honestly, it’s too early to conclude definitively. The upcoming six months may provide clearer insights. However, if the panic displayed in recent days is any indication, it seems that we may be staring down the latter scenario.
Sincerely,
MN Gordon
for Economic Prism
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