In the past week, the stock market has seen a tremendous rise in volatility. Most San Antonians have become complacent because this type of volatility has not occurred in several years.
What is causing this gyration in the worldwide stock markets, and will it continue?
First, San Antonio investors should not look at point swings, but rather toward the percentages of movement in the markets. When the Dow Jones Industrial Average was 10,000, a 1,000-point drop was 10 percent. On Thursday, the Dow’s 1,033-point plummet amounted to 4 percent. While this is an unpleasant experience, each must be put into perspective.
How does that affect people in our city? Rising interest rates in San Antonio’s housing market may mean that some cannot afford the home they wanted, or down payments may have disappeared due to a declining or volatile stock market, or small businesses in San Antonio may find it more difficult to borrow due to rising interest rates, especially those on floating rate lines of credit.
Second, why is this drop – or as some may call it, correction – happening? Many experts claim it is a rise in interest rates. I will agree that this is part of the reason that volatility is occurring. However, one must look further into why interest rates are rising.
What can San Antonians do to protect themselves?
Inflation is not necessarily a bad thing for the marketplace. A moderate amount of inflation promotes wage increases and job growth. The problem comes when inflation increases to a point that causes wages to increase at a faster rate, prices on products we buy increase, and there are not enough workers to fill empty jobs. Then inflation feeds upon itself. Currently, the market expects three rate hikes in 2018, each of 0.25 percent. However, will this be enough to combat what we are seeing as inflation now?
Currently, wages are up approximately 2.9 percent, and unemployment is at 4.1 percent. Five percent is considered full employment, as there are always people changing and switching jobs. Underemployment drives up wages and necessarily inflation as there are not enough qualified workers to fill positions.
The 10-year U.S. Treasury bond has taken a dramatic rise over the past year, with the yield ranging from 2.01 percent to 2.85 percent, settling at 2.7 percent on Feb. 6. The 10-year rate directly affects mortgage rates and many other borrowing instruments that individuals use, such as long-term loans.
The other interest rate meaningful to consumers is Libor, or the London Interbank Offered Rate, which is the rate some global banks charge each other for short-term loans. Libor is directly affected by the Federal Reserve, and its decision to raise interest rates. The current 30-day Libor rate is approximately 1.58 percent. This rate is used to base floating-rate mortgages, credit card rates, prime rates at banks, and car loans. Many times, this rate will forecast a rate hike before it happens.
Some may ask how all this relates to the stock market. The stock market becomes jittery when it sees the cost of funds go up, because now it costs more to do business. San Antonio business people pay more for the items they place on the shelves, through purchase, labor, insurance, and energy. Almost everything that consumers purchase will cost more. Raises no longer go as far as people think. This type of inflation will erode or eliminate newfound buying power.
The stock market is a forward-thinking entity trying to anticipate the cost of business and goods for each business listed.
How each business will have to readjust its individual forecast relies upon a variety of formulas, including something called the P/E ratio, or price-to-earnings ratio. The lower the price (cost of a share of stock) to per-share earnings, the more potentially valuable the company becomes. Prior to the current pullback in the market, the average P/E ratio was hovering around 20, which to most analysts was considered high. Now with the pullback, the ratio has receded close to 18 – closer to what analysts like to see, but not low.
Analysts also will look at the forward P/E, or how much companies are expected to grow over the next year. If the economy is good, then the forward P/E ratio will be lower, and analysts will feel more comfortable about the company and the market and recommend purchasing.
While many San Antonians don’t think this will affect them, it has far-reaching effects on the local level. The prices of clothing in department stores, food at H-E-B, and products at Home Depot all factor into the equation that allows corporations to be profitable for their shareholders.
The economy is in a period of expansion, especially with the new tax bill, which has afforded businesses new capital through lower taxes, allowed them to repatriate funds, raise wages, and employ more workers and infrastructure. We see much of it in San Antonio’s booming housing market, new companies relocating to the area, and new jobs being created. This should help the economy grow at a healthy rate and make this correction relatively short-lived.
Because of this correction and the volatility it brings, San Antonians should proceed with caution and avoid making hasty decisions. Given the Dow’s dips over the past week, including Thursday’s big point drop, there may be a rough ride ahead, but history has shown that investors who hold steadfast in their investment portfolio with a good advisor and good asset allocation tend to come out ahead. Advisors should be communicating with their clients during these turbulent times to explain portfolios and the rationale and safeguards in place.
In my view, there are other underpinnings of the economy that need to be discussed and addressed at greater length, including the tax bill, the long-term holding of sovereign debt by central banks worldwide and the potential effects on the world economy, underemployment and how it affects the workforce and inflation, and the use of certain instruments, derivatives, and trading methods that are currently allowed. All of these potential factors may affect portfolios and are reasons to adequately diversify, plan, and have articulated investing goals. Those goals may include retirement, purchasing a new home, or sending a child to college.
These economic underpinnings also will have a broad effect on small and large San Antonio businesses and their ability to expand and hire, as well as how profitable they become in the future. San Antonio is connected to the world by all of these threads that directly affect each of our lives on a daily basis.
Gosh, and I thought the new tax bill – which would create a $1 trillion deficit – was going to increase government borrowing to pay for the high levels of government spending, which would then crowd out private borrowing and could result in higher costs for smaller businesses (aka excessive inflation).
Oh, and how ’bout that budget deal? More government borrowing?
The economy WAS ALREADY in a period of expansion for several years…and then there was the new tax bill…