On Friday, August 21 American stock markets had a really bad day
with the broad S&P 500 index (roughly the 500 biggest companies
listed on US stock markets) losing well over three percent of its value.
The fall, though certainly large, was by no means catastrophic by
historical standards. But it is having an outsized psychological impact
on stock owners because it comes in the context of what's been an
overall very "meh" 2015 for stocks. Both the real economy and the stock
market crashed from the fall of 2007 all the way through to the spring
of 2009. But while economic growth since that time has been generally
disappointing, the stock market has soared.
In 2015 though, that pattern has broken down.
The economy continues to add jobs at a slow-but-steady pace, but the
S&P index started the year at 2058 on January 2 and was at 2060 as
of early Thursday morning — dead in the water. In that context, the
sudden decline on Friday feels to many like a bad portent. A clear
signal that a years-long bull market is over and now the bears are
running the show.
It's a huge deal for investment professionals, and a sustained
downturn could be very bad for people near retirement. But it's always
worth keeping in mind that most people don't have much to fear from a
stock market decline — even a severe one.
1) Bad news from China supposedly caused the crash
The truth is that nobody has any idea what causes short-term stock market fluctuations. And to the extent that anyone even thinks
they have a way of finding out, they're not going to tell you about it
or blab to the press — they're going to trade and make money.
But broadly speaking the key source of negative sentiment seems to be a run of bad economic news out of China. This has been a story all summer, but the declining price of Chinese currency since mid-August has made it clear that there are real international implications.
You can see the central role of China-related fears in the
extraordinarily poor performance of companies like Apple (down over 6
percent) that have relied on Chinese customers to fuel much of their
recent growth. The China effect is also visible in the price of a wide
range of raw materials, all of which are falling in anticipation of
weaker Asian demand.
None of this really explains why Friday in particular was so bad
(Chinese growth was also slowing on Wednesday) but it's what traders are
thinking about.
2) The stock market's had a great run
Since bottoming out in the spring of 2009, US stock markets have
enjoyed an excellent run. There have been some hiccups in the years-long
bull market, especially centered around America's sporadic political
crises, but mostly it's been an era of up, up, and away for American
stocks.
In part, this is because the economy has grown steadily this whole time.
But overall economic growth has still been much less impressive than
stock market performance. The excess performance of stocks has been
driven by a few factors:
With wage growth slow, the corporate profit share of overall
national income has risen partially offsetting overall national income's
slow growth.
Many big US-based companies have plenty of foreign customers, and
have benefitted from stronger growth in Asia even as the US economy has
been weak.
Low interest rates have made it possible for many companies to
borrow money cheaply in order to spend on share-boosting strategies like
higher dividends or companies buying shares of their own stock.
Optimism that more robust recovery is right around the corner.
3) The stock market's had a bad 2015
In 2015, that party largely came to an end. The profit share of the
economy appears to be shrinking again, as the unemployment rate is now
lower and companies no longer have a limitless supply of cheap labor. At
the same time, the foreign economic picture now looks very different.
The Brazilian and Russian economies are both in a state of chaos, and
Chinese growth is — at best — slowing down.
4) Weak stock prices might not be bad for you
If you are in your sixties, hoping to retire very soon, and have most
of the money that you have managed to save tied up in the stock market
then a period of low stock prices is bad news. But while much economic
commentary simply assumes that low share prices are bad, the reality is
that relatively few people are actually in this situation. If you're not
planning to retire for another two or three or four decades then
cheaper stocks are, if anything, a plus — it means your savings will go
further as a long-term investment.
What's more, for better or worse most people just don't save that
much and the majority of stock is owned by a relatively small number of
rich people.
To the extent that things like a stronger labor market and higher
wages are weighing down profits and share prices, that's good for most
people. To the extent that weak economic growth in Brazil and China is
weighing down share prices, that's terrible for Brazilians and Chinese
people but probably doesn't mean much one way or the other to you.
5) Then again, it could be a sign of something terrible
It's unlikely that declining stock prices will cause bad things in the life of the typical American. But rapid movements in financial markets are sometimes a sign of larger problems.
If American economic growth is slowing down, that's going to be bad
for most Americans. And slower US growth is the kind of thing that would
show up in US stock market prices — probably faster and more suddenly
than it would become visible in official government economic data. Most
people don't seem to think that's what's happening here so you shouldn't
get too worried. But anyone who was really 100 percent confident they
could understand the ups-and-downs of financial markets would be getting
rich, not writing about it on the internet so it's best to admit to
some uncertainty about what's really happening.
On
Friday, August 21 American stock markets had a really bad day with the
broad S&P 500 index (roughly the 500 biggest companies listed on US
stock markets) losing well over three percent of its value. None of this
really explains why Friday in particular was so bad (Chinese growth was
also slowing on Wednesday) but it's what traders are thinking about.
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