Why Stocks Are Riding Market Roller Coaster

Just when the US stock market appeared to be defying gravity, it tumbled back to Earth with a resounding thud. Jittery investors rubbernecking at the Dow and S&P market numbers gulped Alka Seltzer. Panic gripped Wall Street traders who triggered a massive sell off of stocks.

Even before the dust settled, everyone from small individual investors to institutional fund giants were asking the same question: “Is the Bull Market over?”

That question dangled over the market as stocks began a roller coaster ride recently, giving new meaning to the word volatility.  After the end of the bear market in March 2009, stocks have soared into record breaking territory, making this the second longest Bull Market in history.

But the recent gyrations have Wall Street analysts calling the downdraft a correction, a term reserved for a 10 percent drop in market averages. A  20% slide would have signaled the start of a Bear Market.  Last week the market rallied, but the gut-wrenching steep swings may not be over.

Despite the conventional market wisdom, the gyrations are a product of the Federal Reserve’s experimental policy over the last eight years. The Fed propped up the stock market during President Obama’s tenure by lowering interest rates while increasing the supply of money.

Under former Fed Chairman Ben Bernacke, the country embarked on an unprecedented monetary experiment.  The strategy was to repress  the bond market by lowering interest rates, nudging investors into riskier assets such as stocks.  The policy worked as assets prices rose.

Everything from real estate to junk bonds and stocks gained as the Fed drove interest rates to nearly zero while purchasing longer term securities issued by the federal government. At the same time, the Fed flooded financial institutions with capital to promote increased lending.

As a result of the the Fed’s unprecedented maneuvering, stocks leapfrogged to new highs.  However, the market was built on quicksand.  There was no underlying growth to support rising stock prices. Economical fundamentals were soft.  The result was overheated stock prices.

After Bernacke stepped down, new chair Janet Yellen followed Bernacke’s script endorsed by Mr. Obama.  In the twilight of Obama’s reign, when the economy began showing signs of a pulse, Yellen acquiesced and signaled a modest plan for raising interest rates.

Many leading economists were stumped by Yellen’s slow pace.  The experts believed it was time to unwind the Fed’s asset purchases and allow interest rates to move upward at a faster clip.  Despite the lack of economic evidence to continue to weigh down interest rates, Yellen clung to her policy.

The reason for her recalcitrance is the stock market was the one gem in an otherwise dismal economic performance under Mr. Obama. Fed chairs always insist their monetary decisions are unaffected by politics. Don’t believe it.  Everything in Washington is influenced by politics.

That’s why this recent market nosedive should be named the Obama Correction.  The Fed’s policy, which some claim saved the financial industry from collapse, resulted in the slowest recovery from a recession in U.S. history.  Stock traders became rich, but the average American saw far less benefit. 

The good news is the United States economy is shaking off its long malaise.  The Gross Domestic Product (GDP), a measurement of economic growth, hit 3.2 percent in the second quarter and finished the third at 2.6 percent.  GDP numbers for 2017 will be released February 28.

Unemployment has dipped to historic lows. Wages are showing signs of inching upward. Corporate profits are now energized by top line revenue growth.  And more firms are raising their profit estimates for future quarters, an indication there are better days ahead.

Of course, economic growth has a down side for the market.  Analysts are now hand-wringing about interest rates putting a damper on consumer borrowing and spending.  Wall Street is also spooked about fears of inflation as growth inevitably leads to a tight labor market and higher wages.

Even with an improving economy, no Bull Market lasts forever.  The longest Bull Market in history was from October, 1987 to March of 2,000, a period of 4,494 days when the Dow Jones Industrial Average reached 308 all-time highs and spiked 582%.

The current Bull run is approaching 3,000 days.  The average Bull Market lasts about nine years (3,282) days and adds 480%.  Looking at those numbers, the current Bull has room to grow, having added 260% in under eight years.  This Bull may yet become the longest in U.S. market history.