Where Are the Markets Going – And Why?

Is rising volatility a sign the bull run is over?
August 18, 2019 Updated: August 18, 2019

What to make of a 500-point drop in the Dow one day and an 800-point drop on another? And what if the market sees more triple-digit drops? Does it mean the end of the bull market?

Perhaps, but not necessarily.

On the one hand, the temptation to make too much of it is always there, especially for the media outlets. That’s understandable. Hyping doom and gloom in the markets attracts viewers and drives revenues. But on the other hand, there’s much more going on than what the financial media highlights in their soundbites.

Make no mistake about it, the stock market adjustments are a real concern, costing investors real money in their portfolios. But market drops – and the rising volatility – are not limited to simply a reaction against Trump’s trade war with China (more on that in a moment). Nor is the inverted yield curve between the two- and 10-year treasury bonds a concrete sign that a recession is on its way. Both of these are true to some degree, but there are other factors to consider.

A Healthy Economy

Big market adjustments usually come with bad economic news. But for the most part, in the American economy at least, the bad news just isn’t there. For example, economic factors such as falling corporate profits could be a reason, but they’ve actually been more resilient than they were expected to be at the beginning of the year. And, since unemployment remains very low, wages continue to rise, and retail sales are decent, none of those can be viewed as bad news.

Also, the key indicator for the American economy is consumer sentiment and behavior. The retail sector continues to perform well. In fact, it has outperformed analysts’ expectations for July. As a result, consumer sentiment and demand remain positive. This is partially reflected in manufacturer indices registering slightly above 50, which is also a positive indicator.

Summer Profit Taking and Interest Rate Cuts

One potential reason may be that asset prices, at least from American investors’ point of view, may be reaching their limits. There are only so many “all-time highs” that can be reached before investors do some profit taking and sell a portion of their positive positions. Furthermore, lighter summer volume in the markets magnify the impact of sellers’ decisions.

One other factor has had a negative impact by simply by not having one. The recent interest rate cut by the Federal Reserve had virtually zero upside effect on the markets. Worse, further cuts have already been baked in to the market’s expectations. This means that even another quarter or even half-point cut coming from the Fed as early as September will not generate the market-boosting results of the past.

De-Globalization Events Are Important Factors

A more circumspect view may be that, in a globalized economy, the largest, most active market in the world will be affected not just by domestic events, but by conditions in the global markets as well, That would seem to be the case here, but in a contrarian way.

The Brexit vote and the economic nationalism of the Trump administration are leading the trend away from globalism. In this broader context, the trade war with China is definitely a factor, or more accurately, the prospect of it not ending soon or even escalating, may be the source of market jitters. And, given that the new 10 percent tariffs on $300 billion in Chinese products goes into effect on September 1, a bit of profit taking today is understandable.

Perhaps just as critical are the economic data coming out of Europe and Great Britain. The British stock market (the FTSE), has closed at a six-month low. No doubt that anxiety over the uncertainty of Brexit is partly to blame, as retail sales in Britain remain strong. Still, U.S. markets reacted negatively to the FTSE drop.

In the European Union, equity markets also hit a six-month low, but for a very different reason: the engine of the Eurozone, the German economy, is contracting. What’s more, the major economic players in Europe aren’t completely focused on boosting their economic performance. France’s government is preoccupied with gilets jaunes strikes and other protests across the country, Italy is dealing with acute debt problems while Spain faces several challenges, including 14.6 percent unemployment and political uncertainty.

“De-globalization” is real and will continue to diminish trade between China, the U.S. and the Eurozone. It is shifting trade away from China and Europe and into other parts of Asia and Latin America, and potentially more into the United Kingdom as well.

Yield Curve Inversion Due to International Market Distortions

As for the yield curve inversion, it’s not as simple as investors fear a recession is coming and therefore want to buy more bonds. That’s circular reasoning. There are several outside influences related to de-globalization that have affected the bond market that need to be recognized.

In response to recession fears, for example, the European Central Bank is expected to keep rates at zero, lower some deposit rates into negative territory, and restart their asset-buying program. A tack by European bond investors to the relatively higher yields of U.S. bonds isn’t unreasonable. This may be part of the reason for the inverted yield curve in the bond market.

Another factor may be the expected default of Argentina. Having just elected a left-of-center government, the chances a potential Argentina default have risen significantly. A flight to the safety of U.S. bonds isn’t an unexpected reaction. The Hong Kong Crisis and the aforementioned U.S. trade war with China will also drive some investors to the relative safety of U.S. Treasuries.

The U.S. Economy Less Vulnerable to De-Globalization

The key point is that de-globalization will negatively impact the Eurozone and Chinese economies more than it will the United States simply because it is less dependent upon the rest of the world. Part of the Trump administration’s trading strategy is to expand trade with the UK and Asian manufacturing countries such as Taiwan, Vietnam, and the Philippines, as well as expand it in the United States. How successful it will be remains to be seen, but rising volatility in global markets – and in the U.S. equity markets – will continue for some time.

James Gorrie is a writer based in Texas. He is the author of “The China Crisis.”

Views expressed in this article are the opinions of the author and do not necessarily reflect the views of The Epoch Times.