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There's No Sound Economic Explanation for Dow's Plunge

There's No Sound Economic Explanation for Dow's Plunge
(Dollar Photo Club)

By    |   Tuesday, 06 February 2018 08:18 AM

Jay Powell started work Monday as Federal Reserve chairman and notwithstanding he didn’t have anything to do with it, the Dow Jones Industrial Average fell by the largest single-session point decline on record, or 1,175 points, or 4.6 percent.

Anyway, it’s a fact that the equity market moves of the last couple of days have been significant, but mainly only when considered in context of the seeming calm on the financial markets of the past couple of years.

The traders who had forgotten what “volatility” is, this is something of an awakening call.

Now, economically speaking, there is nothing to justify this sort of move. Monetary policy outcomes have not changed. The inflation outlook is no different while average earning in the United States remains an as flawed a statistic as everything else was, and so forth…

Global growth is likely to come in at or a bit above trend and GDP growth alone is entirely consistent with global earnings growth of around 10 percent.

Sentiment plus click-bait sensationalism rather than sound economics would seem to be behind the more recent activity.

However, a move like the one we are experiencing in equity markets, if it is sustained (!), may have some economic consequences.

Listed companies themselves are not especially important in economic terms. They are a distinct minority of economic activity and of employment in the United States as in any developed economy in the world.

The move in markets is unlikely to significantly change the cost of capital, and the cost of capital is not a constraining force on corporate investment at the moment.

Rather, any impact, of course if any, will likely to be provoked by the wealth effect. A sustained loss of wealth might affect consumers.

Against this we have to weight the strength of the U.S. labor market. For most Americans, the labor market matters far more than equities because most Americans have jobs, but almost half of the Americans do not own equities, and equity ownership is concentrated into a small group.

Of course, in Bitcoin terms, equities are simply soaring. Any investor, foolish enough to believe that Bitcoin is a viable currency must be very positive on equities right now, though less positive on their spending power.

Bitcoin broke down through $10,000 on Thursday of last week on February 1. It has then broken down through $9,000, $8,000 and $7,000 on each subsequent day.

All this is as if there is a pattern.

The bursting of the Bitcoin bubble is different from the stock market move.

Ownership of equities is still relatively broad, but also relatively shallow. A large number of people own some equity.

Participation in the Bitcoin bubble seems to have been narrow, but deep.

Globally, a small number of people own Bitcoin, but a number of participants in the Bitcoin bubble put everything, or a too large part of their possessions, into a gamble that could yield nothing, or nearly nothing.

In macroeconomic terms, the bursting of the Bitcoin bubble is the final stage of a transfer of wealth to a relatively small number of sellers with no fundamental underpinning to give a floor to the value of Bitcoin.

At an individual level, this is potentially devastating in a way that the equity noise, underpinned by strong economic fundamentals, is not.

In this climate, economic data is not going to play much of a role although the rather politically sensitive issue of the U.S. trade balance is due. That will be the December data, so the impact of the Trump tax cuts on import demand into the United States will not be in evidence yet.

Finally, over in Europe, yesterday ECB President Mario Draghi spoke to the European Parliament and confirmed his still dovish attitude stating: “… While we can be more confident about the path of inflation, patience and persistence with regard to monetary policy is still warranted … We expect our key interest rates to remain at their present levels for an extended period of time, and well past the horizon of our net asset purchases.”

Investors could do well not counting too much on any form of ECB tightening any time soon. On the contrary, I still wonder if there will be any rate hike at all before Mr. Draghi leaves the ECB in October 2019.

Etienne "Hans" Parisis is a bank economist who has advised investors on financial markets and international investments.

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There’s No Sound Economic Explanation for Dow’s Plunge
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Tuesday, 06 February 2018 08:18 AM
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