Global exchanges are currently enduring one of their worst weeks in recent history. The chart below reflects the performance of the Dow Jones Industrial Average which was trading at 24,409.83 (February 6, 2018) after plunging from 26,186.71 on 1 February 2018. The 52-week trading range of the all-share index is 20,002.81 on the low end, and 26,616.71 on the high-end. While markets have witnessed a sharp selloff in recent days, the current level of the Dow Jones is on par with its performance in December 2017.
The correction of several percentage points saw the 50-day moving average (25,048.51) rising above the current level of the Dow Jones, however the 200-day moving average of 22,740.63 remains well beneath the present level. Corrections are entirely normal in stock markets, and as much has been indicated by leading economists. Recently, Mark Cuban – the billionaire owner of the Dallas Mavericks, had this to say about the recent performance of the stock market:
‘When you have a run-up like we’ve had since the election, markets don’t go in a straight line for ever so if something had to happen it was just a question of what, when and how much.’
This begs the question: What is driving stock market volatility? The short & sweet answer is rising interest rates and rising inflation. The relationship between interest rates, inflation and the stock markets is particular interesting. There isn’t a linear relationship that explains the movements of stock prices when consumer sentiment anticipates a Fed rate hike.
According to Olsson Capital investment guru, Montgomery Smyth Sr,
‘Think of the broader economy for a moment. When household debt is sitting at around $13 trillion, and there is chatter about interest rates rising in March 2018, people get nervous. What does this mean? Simply put, people will be paying more on their outstanding debt, leaving them with less disposable income. For companies listed on the stock exchange this translates into lower sales. But there’s another side to this equation: Debt levels that are currently incurred by companies in an era of rising interest rates tend to rise accordingly.
Companies borrow from banks, and banks charge interest rates that are closely aligned with the federal funds rate. When that rate rises, banks charge more to their customers. Many of these customers are Wall Street players. When their variable interest rate repayments rise in an inflationary climate, profits decline. This leads to lower stock prices in the long-term. There’s also another factor playing its part right now. This relates to the shifting of funds from stocks to bonds. When interest rates rise, bond prices drop, and people find it more attractive to invest in safe-haven interest-bearing assets rather than ones which are likely to fall such as stocks.’
Rising debt levels are commonplace in an economy where consumers have a bullish feeling about their spending habits. Credit card debt has topped $1 trillion, and mortgage debt is approaching the level set at the time of the 2008 global financial crisis. Rising student debt and automobile debt are also testament to an economy on the mend. However, a credit-driven economy does not necessarily bode well for GDP growth if households are unable to service that debt. Fortunately, wage growth is keeping up with inflationary pressures in the US, meaning that economic performance is not under threat. Recall that 200,000 jobs were added in January 2018, lending credence to the notion that the US economy will see rising inflation as higher wages filter through markets. This all but assures markets that a March rate hike will take place. According to the CME Group, the probability of a Wednesday, March 21, 2018 rate hike is now 69%.
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