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


  • A Few Notes on Market Sell-Offs

 

A Few Notes on Sell-Offs


Markets continue to sell-off, which is always unpleasant but impossible to avoid if you want the kind of long-term capital appreciation that common stock investing has provided. Unfortunately many investors, understandably spooked by the 2007-09 financial crisis, have tended to see signs of a similar collapse whenever normal market corrections occur. This rests upon a fundamental misunderstanding of that episode. There was no “event” that could have been foreseen. The financial crisis was the sum total of a series of events and policy responses that were not knowable in advance, because government responses – good and bad – weren’t known in advance. Specifically, the crisis began in the subprime mortgage market, threatening the viability of many financial institutions. This led to a modern-day version of the 1930s bank runs (only by institutions rather than people). In that 1930s period, “liquidationists” argued that banks and financial institutions should be allowed to fail (rather than be bailed out by the government), and that their assets should pass to stronger survivors. That view won the day, and the Central Bank (Federal Reserve) failed to act as a lender-of-last-resort, even though that was one of the reasons for its creation. Milton Friedman’s work on how the Fed allowed the banking system to collapse, causing a deflationary spiral, helped to win him the Nobel Prize. During the more recent 2007-09 crisis, the Fed allowed Lehman Brothers to fail (there was some legal ambiguity here). This, as Fortune magazine described it,


“Sent shockwaves through the global financial system, accelerating the crisis until leaders of the seven largest economies met and pledged to not let any more systemically important financial institutions go under…the much-maligned bank bailouts, while politically unpopular, helped the world avoid a Great Depression-style meltdown.”


So you can see (I hope!) that it is somewhat absurd to say anyone “called it” or predicted this series of policy responses in advance. In the same way, I think it is a little absurd to read into the current sell-off anything more than an “expected but not predictable” market downturn.


Another take on the current sell-off that I think is interesting comes from economist Mike Englund, of Action Economics. Speaking this morning (12/17/2018) in a brief podcast, Dr. Englund made the point that the media crafts narratives around the market. So when the market is down, the media point to whatever negatives are out there as reasons for it being down. If the market is up, it looks to whatever positives are out there to explain why the market is up. Most of the time the positives and negatives coexist; it is the market’s movement that day that determines which – the positives or the negatives – are mentioned. And that leads to Englund’s main point: “You can’t extrapolate market narratives!” In other words, what the media is talking about today, i.e. the market narrative, has no relevance regarding the market tomorrow. I thought that was clever and insightful.


I’ll conclude with a summary of strategists polled by Bloomberg (reported in the Financial Times): The median estimate for the S&P 500 by the end of 2019 is 3090 (currently 2545), with 10-year US Treasury yields at 3.44% (currently 2.85%).