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Stock markets around the world witnessed mayhem as there was a sharp sell-off of stocks on February 5th and February 6th this month. Stocks went into free fall as soon as the official figures showed an average wage rise in the US to be at 2.9%. It was on January 26th, 2018 that the US DOW Industrials topped at 26,600 and suddenly on Friday, February 2nd, 2018, the DOW Industrials crashed 666 points. This was followed by a bigger 1,175 points drop in the DOW on Monday, February 5th, 2018 its biggest drop-ever in points, though the in percentage terms, the 4% drop was not the worst. Continuing into Friday, February 9th, 2018, the DOW Industrials crashed another 2,200 points all the way down to 23,344 (in total crashing over 12% since topping on January 26th, 2018). The volatility index, VIX, gained over 50% as the drop continued to drop traders throughout the week. [1]

American markets, by virtue of the world’s largest, inevitably send ripples around the globe. The famous phrase “when the US sneezes, the rest of the world catches a cold” came to life. The plunge on Wall Street caused markets in Asia and Europe to fall on the same day. Japan’s Nikkei dropped 4.7%, Hong Kong stocks plummeted 5.1%, and London’s FTSE 100 was down by nearly 2%. Having said that, markets in London and Tokyo are particularly sensitive to activities in the US, while those in China are less effective due to their restrictive nature of trade. The Indian markets, showcasing their correlation with the US markets also fell nearly 3.5% after already being under pressure due to re-introduction of the Long-Term Capital Gains Tax in the Budget. 

Unemployment under the Trump administration is historically low, and there are more open jobs than people to fill them. In order to retain the existing workers, companies have started to pay their employees more which get converted into a rise in the general price level (inflation). It was feared for several weeks that inflation levels in major developed economies could increase this year beyond the absorbable level of 2%-3%, and with a staggering wage rise of 2.9%, a rise in inflation is almost certain[2]. The Federal Reserve foils high inflation with enhancing interest rates. Increased interest rates are equivalent to an increased cost of borrowings for Americans and deduction in corporate profits. The worry of decreased profits often leads to sell-off as investors pull their money out of the industry.

Stocks in the US have always been more attractive against the bonds, owing to low yields on bonds. Having said that, stocks also carry higher-risk investment than bonds, since bonds are backed by the United States Treasury. In a situation where bond yields start to rise, investors will automatically transfer funds from a stock-rich portfolio to a bond-rich portfolio. The recent tax bill by Trump Administration has forced the Treasury to borrow more money, which will put more bonds into play, which was evident as the US bond yields hit a four-year peak, jumping from 2.1% in September 2017 to 2.8% this month[3].

While there’re a number of reasons why stocks markets could’ve plunged, the fact that it happened after stocks kept strong for nine years straight is absolutely fathomable. Stock markets go through a correction phase, which is simple terms is known as a negative movement in major stocks (of nearly 10%) from a recent high. For a fact, 2017 set 40 records throughout the year; stock markets kept going rising. The DOW hadn’t been in a correction- a decline of at least 10% from a recent high, since February 2016[4]. In short, February 5th decline doesn’t give signs of recession. The DOW and S&P were in negative territory but are still up about 20% and 15%, respectively, over 2017.

The economic parameters of the US economy continue to grow strong, increasing potentials of a higher interest rate. Even the Fed has decided to raise the interest rates this year- two/three times without having consensus on the frequency. The new Trump-tax bill which already made through the Congress is expected to inject more than the US $ 1 trillion in the country’s economy, much in the form of corporate tax cuts[5]. Falling unemployment coupled with rising corporate profits makes both, rising inflation and stock market jitters certainly. This would trouble many countries that trade heavily with the US, specifically those borrowing in US dollars. All in all, 2018 will not be as stable as the previous year, no matter if it’s called a crash or correction.

 

[1] Monthly Update by MarketWatch, accessed on February 18th, 2018, https://www.marketwatch.com/investing/index/djia/charts

[2] Report by The Reuters, A decade after recession, a jump in US states with wage gains, accessed on February 17th, 2018, https://www.marketwatch.com/investing/index/djia/charts

[3] Report by Bloomberg, Bond-Market Pain Reaches 30-Year Treasuries as Yield Breaches 3%, accessed on February 18th, 2018, https://www.bloomberg.com/news/articles/2018-02-01/bond-market-pain-reaches-30-year-treasuries-as-yield-breaches-3  

[4] Bi-yearly update by MarketWatch, accessed on February 17th, 2018, https://www.marketwatch.com/investing/index/djia/charts

[5] Report by CNBC, Senate tax bill would fall $1 trillion short of paying for itself after economic growth, congressional analysis say, accessed on February 18th, 2018, https://www.cnbc.com/2017/11/30/senate-tax-bill-would-still-add-1-trillion-to-the-deficit-after-growth-congressional-analysis-says.html

 

Image Source: CNN Money

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Written By Parth Gupta

Political Analyst | Economics Students | International Laws

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