"Kee" Points with Jim Kee, Ph.D.


  • The Stock Market
  • The Fed and the Economy


The Stock Market

There has been a lot of stock market volatility in recent weeks, with stocks in the U.S. now about flat for the year, and mostly negative year-to-date outside of the U.S. The S&P 500 is off about -8% from its recent record high on September 20 (Barron’s), with the tech-heavy NASDAQ down even more. At the beginning of the year I suggested that “surprising growth, disappointing returns” (a Blackrock analyst quote, as I recall) was probably the best way to think about things going into 2018, and that’s pretty much what we have seen. The idea is that prices lead quantities, so while economic numbers like GDP and employment should be pretty strong because of the interaction of tax cuts and deregulation, markets (prices) tend to move first, so a lot of the good news was probably priced-in. In fact, what surprised me was the surge in stocks in the third quarter, which of course has reversed itself in the past few weeks. Perhaps earnings were even stronger than expected (by the market, not “analyst” expectations), or perhaps there was more optimism on China trade discussions than we have subsequently seen. Keep in mind that nobody has a stock market valuation model precise enough to say for sure what exactly was priced-in and what was not. However, there are plenty of charlatans out there who will claim to. In addition, market patterns this year are nearly the same as in prior-mid elections years, i.e. strong start and then a sell-off and a lot of choppiness going into the election (Nov 6) period. Whenever volatility in the market picks up like this, I think it is helpful to ask, “did I not believe that stocks would have pull-backs and corrections?” Of course, they will! That brings me to the second kind of charlatan, those who think they can get out of and then back into the market to avoid the chop, i.e. successfully “time” the market. There is zero peer-reviewed research to indicate that this is possible, but plenty to indicate the poor results from trying to do so. Jack Bogle, in one of my favorite quotes in the business, said it best: “There are two kinds of people in the world, those who don’t know where markets are going, and those who don’t know they don’t know where markets are going!”

 

The Fed and the Economy

Whenever you get a decent sell-off in stocks, you also get a lot of recession talk. That is because, as I mentioned above, prices lead quantities, and recessions tend to be preceded by stock market sell-offs. However, stock market sell-offs aren’t always followed by recessions, hence Nobel Laureate Paul Samuelson’s famous 1966 Newsweek quote that the stock market had predicted nine of the past five recessions.


Subsequent updating has shown that bear markets (-20% or more declines) in stocks are followed by recession about 53% of the time (CNBC), so not much better at predicting than a coin toss. If that were not the case, macroeconomists would just pop the stock market into their forecasting models and be on their way to huge success. However, the market is too volatile, i.e. signals too many downturns that never occur. I’ve tried it, as has every other economist on the street. By the way, no indicators that have a track record at anticipating recessions are signaling one now. Many blame the market’s angst on President Trump’s recent verbal attacks on the Federal Reserve for raising rates, and on concerns that the president might try to influence the Fed and threaten our central bank's independence. Actually, Trump’s comments followed the market decline, they didn’t precede it. My view is that President Trump will continue to complain as the Fed raises rates and that Fed Chair Jerome Powell will continue to ignore him. In fact, in a recent event hosted by the Federal Reserve Bank of Dallas I asked Principal Policy Advisor Evan Koenig that very question, i.e. is Trump a threat to Fed independence? He replied that he had been with the Fed for over 30 years, and intimately involved with FOMC meetings for over 5 years, and that he has never heard politics given one iota of thought when it came to Fed policy decisions (that is my translation of his answer). Therefore, I would not pay much attention to the media’s “President versus the Fed” hype.