Why You Shouldn't Melt Down With the Markets
WHY YOU SHOULD CARE
Recent stock market turmoil has many worried about their portfolios — and wondering what’s next for the economy.
By Simon Constable
Simonomics: A regular look at the global economy from a former staff columnist at The Wall Street Journal.
We understand. You’re freaking out. If only a little.
Sure, the Dow managed to plunge — and we mean plunge, more than 1,000 points yesterday morning — before recovering some. The end result over the past few market days is pretty awful. It’s now at its lowest close since February 2014.
But the real question, and we’re not just trying to make you feel better, is not where the market is heading, but where the economy is heading. And here, it’s not so bad. Really. In fact, the services-based businesses accelerated their expansion last month, while existing home sales figures released last week show the country is still solidly growing. “The recent sell-off in stocks does not reflect significant problems in the U.S. economy,” says a report that PNC Bank released on Friday, which added the economy “will continue to expand.”
It’s not the first time that this has happened. Nearly three decades ago, in October 1987, more than a fifth of the value of stocks was wiped out in a single trading session, dubbed Black Monday. Many reasons were fingered for that particular meltdown. But here’s one that stands out: A hurricane hit the U.K., causing massive and unexpected damage. Insurance companies sold stocks in New York to pay for the damage. Did that slow economic growth? Not at all. The U.S. economy grew robustly, more than 4 percent for the year starting that October, according to inflation-adjusted data from the St. Louis Federal Reserve. The stock market also bounced back fairly quickly.
If people get alarmed enough, this could drive what’s known as the negative wealth effect, and economic growth could suffer.
Fast-forward to 1997 and 1998, when the so-called Asian Contagion swept the globe before the Russian debt crisis got on investors’ nerves. Both periods saw stock markets pull back dramatically, but U.S. growth didn’t slow. Again, it remained above an annualized 4 percent both of those years. That situation was helped, in part, by U.S. government agencies that acted to head off the overseas crises, explains Sam Stovall, a U.S. equity strategist at S&P Capital IQ in New York.
Then there was the dot-com bust. From its then peak in 2000 through the 2002 low, the Nasdaq Composite index, which includes many technology companies, shed more than three-quarters of its value. Sure, the economy went through a recession, but it was the shallowest since World War II, says Stovall. And the cause of the stock drop — the unfulfilled promise of a new Web economy (Pets.com, anyone?) — spelled bad news mostly for tech startups.
Of course, there’s a major exception in all of this: the financial crisis of 2008-09. Given its recency, it’s no wonder so many investors have the jitters today. If people get alarmed enough by the shrinking size of their stock portfolios, the fear could drive what’s known as the negative wealth effect, where even though your income hasn’t changed, you feel poorer and so spend less. Around two-thirds of the U.S. economy depends on spending, so if that happens economic growth could suffer.
But we’re not there yet. The recent sell-off in stocks reflects concern over China’s slowing growth, and some in the U.S. are nervous that the Federal Reserve may raise borrowing costs. On top of that, the strong U.S. dollar is depressing earnings of the biggest companies here, as just under half of their revenue in the S&P 500 index comes from outside the country, according to a recent study from S&P Dow Jones Indices. If overall earnings actually fall, then we’d have a profits recession, which investors won’t like. Yet these are just the worries. For now, the U.S. economy is actually doing OK.
- Simon Constable, Neil Parmar likes to report, write, edit and teach, so he tries to do plenty of each. (Can you tell he's a big fan of Dr. Seuss?) He has written for The Wall Street Journal, Money, Psychology Today, Inc. and other publications that are informative but not nearly as much fun as The Cat in the Hat. Follow Simon Constable on Twitter Follow Simon Constable on FacebookContact Simon Constable