As suggested in article below from 3/1 the Federal Reserve (Fed) caved today with an emergency interest rate cut, bringing the Federal Funds Rate (overnight borrowing and lending rate for banks) down 50 basis points from a range of 1.5-1.75%, to 1-1.25%. While claiming "economic fundamentals" are still strong, there is concern over the impact on output from the rising concern over Covid-19.
This is a mistake and further entrenches the moral hazard for investors who keep expecting to be bailed out every time stocks turn down as they have once again have been given a life line. The pain suffered by savers and retirees over the past 10 years will continue for at least another year.
The conduct of monetary and fiscal policy we see today is unprecedented and unsustainable. The Fed has created nearly $4 TRILLION out of thin air, and the President and Congress are content with yearly budget deficits fo $1 TRILLION or more for years to come. There will be a price to pay.
The Fed must normalize rates (Federal Funds Rate in a range of 3.5-4%), and Congress has to get a handle on TRILLION dollar deficits. Our policy leaders must stop trying to manipulate the stock market and allow markets to function based on the fundamentals of valuing a company, cash flows, and the business cycle. All we are doing is borrowing demand from the future; it won't end well.
After the emergency rate cut was announced President Trump called for even more rates cuts. No! America does not want zero or negative interest rates.
What To Do In A Falling Stock Market
Stock market action as we have witnessed since Monday 2/24 is when brokers, analysts, and financial advisors earn their money. To be sure panicked retail investors are lighting up their phones with two simple questions: what is happening?, and what do I do?
It has been a historic week. Not even during the Great Depression did the stock market drop from the high as quickly as we observed this past week. There is only one reason for that: algorithmic trading models dominate trading today (bring back the humans). By Friday the S&P500 was down 8 percent losing 253 points from Monday's high of 3204. Apple, down 7 percent losing $27 per share from a high of $302. Amazon, down 7 percent losing $145 per share from a high of $2035. Microsoft, down 6 percent losing $11 per share from a high of $174. Google, down 6 percent losing $82 per share from a high of $1434, and Facebook, down 10 percent losing $10 per share from a high of $203.
The answer to the first question, what is happening?, comes easier than that for the second. What is happening is a long overdue correction for stock market valuations that have been boosted for several years, not by market fundamentals, but by extraordinary global monetary policy (near zero, zero, or negative interest rates, and unabashed money printing). Moreover, the 2017 corporate tax cuts, unrelenting share buybacks (company's using their own money to buy back their own shares), and the regular and unusual jawboning to boost stocks by President Trump and his economic team mostly related to the Phase 1 U.S./China trade negotiations have kept a bid in the stock market.
Just on Friday, President Trump's Economic Advisor Larry Kudlow urged American's to "buy-the-dip" because "the fundamentals of the U.S. economy are strong." U.S. bond market traders disagree as they pushed the U.S. 10 year treasury bond rate to a low of 1.13%. This price action resulted in further inversion of the U.S. yield curve from Federal Funds rate (overnight borrowing/lending rate, the effective Federal Funds rates closed at 1.58% on Friday 2/27) to the 10 year treasury bond. This degree of yield curve inversion is a strong sign that a recession is on the horizon.
In 2007, Kudlow was similarly optimistic, though wrong at that moment, saying then in the midst of the housing and stock market crash to the National Review“Despite all the doom and gloom from the economic pessimists, the resilient U.S economy continues moving ahead quarter after quarter, year after year, defying dire forecasts and delivering positive growth.” In 2008, well into the great recessions he said "we are about to enter the seventh consecutive year of the Bush boom. Anyone who thinks otherwise are going to wind up with egg on their faces.” His timing was off. The lows that we set in March of 2009, and a 10 year rally ensued.
President Trump has tied his political success to the rise in stock prices since early 2017. He claimed ownership of the rally, he will be given ownership of the sell-off.
The catalyst for this past week's sell-off from near record highs has been the economic consequences of the Corona virus (covid-19.) More precisely, the consequences of the western world's largest corporations offshoring their manufacturing facilities to China, including the production of important medicines. Because of the efforts by the Communist leadership in China to stem the outbreak by quarantining hundreds of millions of people, and the timing of that process having started during the travel season associated with New Year celebrations, production has come to a grinding halt. Workers either can't get to work, don't want to go work, or are not allowed to go to work. Global supply chains (China) augmented by reliance on just-in-time inventory management systems have exposed a serious weakness for western economics as led by the U.S.
The answer to the second question, what do I do?, is qualified by "it depends." It depends, among other things, on when stocks were bought, risk tolerance of the investor, and investing time frames (short-term trader, vs long-term investor). Investors, professional or retail, have five primary options:
First, ride it out. Since the 1980's the technical charts say the long-term trend is higher and markets always recover. Riding it out results in anxiety, sleepless nights, change in consumption habits (the reverse "wealth effect"), and a whole lot of finger crossing.
Second, set disciplined stop-losses. This is about principal preservation. A stop-loss is a price below where you initially bought a stock at which point you do not want to lose anymore principal. This is about reducing losses.
Third, for those with stock positions still in the money (current price is higher than initial entry price) use a trailing stop. This is an effort to book a return, less that could have been gained at the high, though still above your entry point. Instead of gaining a 20 percent return, you book a 10 percent return with the intention of buying again after the bottom has been identified and markets calm down.
Forth, one can short the market. There are fees associated, and it involves borrowing shares from a 3rd party, though this allows for selling high and buying low and making money in a falling market. This is easier for market professionals than for retail investors.
Fifth, always run a long-short portfolio strategy. You own a mix of stocks, those you expect to increase and value, and those you expect to decrease in value.
The only one who can make this decision is the investor. Brokers, advisors, financial planners can recommend, though ultimately it is up to the individual. These are stressful time for traders and investors. So far this past week the multi-year tried-and-true practice of "buying the dip" hasn't worked. It will at some point, we just can't be sure how far down that might be.
It is very likely central banks led by the U.S. Federal Reserve will attempt to boost investor confidence this coming week by talking about more injections of money into the system, that they stand ready to act, and "all is well" commentary. It isn't clear why more or cheaper money would compel workers afraid of catching a deadly virus to return to work in China.
Note: Policymatters USA does not manage money, and all final investment decisions are up to the individual investor.