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The stock market tumble in October was shocking for portfolio holders, especially after a 3% fall on Wednesday that canceled out the year's gains. Could this be the beginning of a bigger crash, or a recession?
Of course, that could. But even before taking into account the moderate market rebound on Thursday morning, it makes more sense to see this massive sell-off differently. It's not a crash, it's a reset. The economy is changing in a way that is not optimistic for stock prices in the years to come, but it is mostly good news for the economy and for ordinary people trying to make a living.
The bull market that will be 10 years early next year was, for the most part, a dream for equity investors.
In the United States, economic growth has been buoyant, but global growth has been slow – which has kept interest rates low, making equities an investment more attractive than cash or bonds in comparison .
Low growth and high unemployment meant that companies had little incentive to pay more for their activities. contributionsincluding manpower and raw materials. If a worker asked for a raise or a supplier threatened a price increase, the alternatives were numerous.
At the end of this bull market, the Trump administration has made its flagship domestic policy initiative a sharp reduction in the corporate tax rate, which translates directly into higher after-tax profits for shareholders.
These three factors combined were enough to propel the Standard & Poor's 500 up more than 300% from its March 2009 low to its recent high of September. But now, all three are changing.
The economy is warming enough for interest rates to reach more normal levels. This is partly due to Federal Reserve rate hikes aimed at preventing the overheating of the economy and excessive inflation, which President Trump has attacked.
But it's not just the Fed. Even long-term interest rates that the Fed does not control directly have risen sharply over the past year, as have longer-term rates in other countries. UK, German and Japanese bond yields all rose over the same period.
If you consider the stock market solely in terms of valuation – how much you must spend to buy stocks for every dollar of profits you capture – the fall of the stock markets in recent weeks can be explained largely by the rate hike in the long term for the same period.
If you look at the price / earnings ratio of the S. & P. 500 stock, for example, and reverse it to consider it as the profit / price ratio, it was 4.77% on September 1st, which means that Buying $ 100 paid you $ 4.77 in corporate profits. After the drop in inventories, this percentage had risen to 5.23%.
This jump is closely linked to the rise in long-term bond yields, which, again, are mainly driven by an improvement in growth prospects. The yield on 10-year Treasuries fell from 2.85% to 3.13% over the same period.
Higher interest rates have made bonds more attractive, so it makes perfect sense for investors to demand a more favorable valuation of equities given this alternative.
The situation could be different if investors felt that higher growth would have disproportionate effects on corporate profits. But the current economic moment offers many reasons to believe that this will not be the case.
Earlier in the expansion, there may have been a lot of marginal workers and companies leveraged their suppliers. However, some signs are changing, as 3M and Caterpillar recently stated that their input costs were rising, which contributed to the start of the recent market crisis.
This is bad news for the actions and results of larger companies, but good news for American workers. When you hear a phrase during a business call such as "input costs increase," keep in mind that the salaries you receive are one of those costs.
Finally, while the first major economic initiative of the Trump administration, the tax cuts, was an undeniable advantage for the actions, the focus this year was on a trade war, especially with China.
So far, the scale of tariffs has not been large enough to have a significant impact on overall economic growth. However, some blue chip companies producing steel or aluminum products (whose prices have risen due to tariffs) or importing key parts from China have had a direct impact on net income.
As companies try to redirect supply chains or absorb higher costs to avoid driving up prices to consumers, the trade war could have far greater effects on big business results. and therefore the price of their shares than for ordinary consumers.
In summary, the fall of stock markets in recent weeks is not a mystery to solve, nor a warning of horrible things to come, but rather the inevitable result of economic expansion that has reached a more advanced stage of maturity .
The stock market is forward-looking and not backward – stock prices are determined by what investors think of the future. And the economic future is starting to be very different from the past.
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