Perspective On The Stock Market

Some people are getting a little spooked by recent stock market movements. Here I offer a few thoughts.

Although there has been a dramatic drop in the S&P 500 since October, the market had been up pretty significantly from the start of the year up to that point. As of Friday, the net change between the start of the year and now has been inconsequential.

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Cumulative change since start of year of U.S. S&P 500 (green), Shanghai composite (blue) and German DAX (purple). Source Yahoo Finance.

If somebody should be worried, it should be the Chinese or Europeans, where the drop in stock prices so far this year has been fairly painful. One interpretation is that bad news for them is finally catching up with the U.S.

It’s interesting that the rise and fall in U.S. equity prices this year paralleled that for the 10-year Treasury yield. That also had been climbing significantly during the year, only to drop dramatically the last few months.

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Interest rate on 10-year U.S. Treasury bond. Source: FRED.

Other things equal, lower interest rates would usually mean higher stock prices, because it means future dividends and earnings are less significantly discounted. When instead interest rates and equity prices move together, as they have been, it suggests that some third factor is driving both yields and stock prices. One possibility is that the U.S. fiscal stimulus both raised long-term real interest rates as well as near-term real growth forecasts earlier this year. One outcome I anticipate as a result of the recent U.S. election is less fiscal stimulus, which would bring both stock prices and bond yields down from earlier highs.

There are some other measures that raise some concerns. New claims for unemployment insurance are one of the best leading indicators we have, and those have been inching up. But again, that’s mostly noticeable because of the long previous decline.

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