Note: This article is for informational purposes only and should not be taken as professional investing advice.
February has been brutal for stock markets.
One look at the charts confirms it all: We are in the midst of a substantial market correction.
From a high of 26,500 to current levels of 24,514.54, the Dow Jones Industrial Average is clearly in short-term bearish territory. It’s worth pointing out several things from the recent performance of the DJIA.
For starters, the 50-day moving average of 25,104.33 is now above the current level of the Dow Jones.
This indicates that the current performance is worse than the performance of the Dow Jones over the past 50 days. More importantly, the 200-day moving average of the Dow Jones Industrial Average remains well beneath the current level, at 22,781.48. This is more significant for investors. It shows that the long-term trends remain upbeat, despite the short-term volatility we are experiencing across the board.
Wilkins Finance investment guru, Charles S. Braun Esq. believes the fundamentals of the markets are structurally sound:
“…Now is a great time to be investing in equities markets. This may appear to be contrarian investment philosophy, but it is based on structurally sound principles. Value investments are achieved every time markets undergo a correction. The current drop in major bourses has not quite reached the 20% correction territory, but prices have dropped just enough to make it enticing for bargain hunters to pick up great stocks at a fraction of the price they would trading at.
We firmly believe that the correction in equities prices and the selloff that has facilitated a transfer of funds to bonds is warranted. For starters, this will give the Fed the breathing room it requires to prevent a rapid escalation in interest rates. Now that the Fed has witnessed a tapering of sentiment in stocks, there is no urgency to rush ahead with interest rate hikes. That being said, the CME Group which tracks the probability of Fed rate hikes believes that there is a 77% likelihood of a 25-basis point rate hike on Wednesday, 21 March 2018.”
The Prospect of a Rate Hike and Stock Markets
There is truth to the notion that interest rate hikes do not bode well for stock markets. A once-off rate hike may not do much to stock markets, but the possibility of a sustained series of rate hikes will certainly impact equities markets. When interest rates are rising, banks are charging all borrowers more interest on capital that is loaned out.
This cuts deep into the profits of listed companies since they are paying more of their profits to banks, but more importantly it reduces the personal disposable incomes of consumers who have high levels of household debt. At the time of writing, US household debt was approaching $13 trillion. Credit card debt already stands at over $1 trillion. Rate hikes mean that it is more expensive to service that debt, and that means there is less money available for spending in the economy. This drags down sentiment in equities markets.
Fed is Happy with Modest Growth in Equities Markets
The Fed does not typically like to tighten monetary policy to counter stock market booms. The Fed is only interested in maintaining price stability and full employment. Those are the 2 overarching objectives of the monetary authorities. When equities markets perform self-correction, the Fed doesn’t need to intervene. However, the Fed must act when runaway inflation grips the economy. If prices are rising, the Fed needs to rein in those price increases by higher interest rates. Higher interest rates reduce expenditure and encourage saving – thereby reducing overall inflation.
When there is more to be gained through investing your money in interest-bearing accounts and bonds, and the cost of financing becomes too expensive, inflation is nipped in the bud. If equities prices can rise unabated, this will naturally lend itself to higher asset prices, product and service prices throughout the economy. The net effect is that there is so much farther for the economy to plunge in such a scenario. Rather than rampant growth on equities markets, the Fed would prefer modest growth. This will limit the number of Fed rate hikes in the year, and temper expectations in the financial markets.