For investors, 2018 is going down as “The Worst Year in 100 Years” or “the worst year ever” and “the year nothing worked.” Virtually all asset classes posted negative returns for the year. The epic stock market run since 2009 seems near an end.
Investors as a class are unlikely objects of sympathy; they already have plenty of money, which allows them to save and invest.
But, on an individual basis, last year’s financial market turmoil means retirements pushed off, college savings shortfalls, new investments not made, entrepreneurial companies not funded, and, for governments, lower capital gains tax receipts.
What demands Washington’s attention is that today’s rocky financial markets are not just a turn of fate or normal cyclicality but a direct consequence of federal government actions.
It likely is widely held that boosting or propping up the stock market is an inappropriate government objective, but, by the same token, harming financial markets is uncalled for and must be stopped.
The primary offender assaulting investors is the Federal Reserve’s quantitative tightening (QT) program, which is draining $50 billion a month from financial markets to unwind the Fed’s earlier quantitative easing (QE) program that ballooned the Fed balance sheet by 20 percent of U.S. GDP.
The goal of reducing the Fed’s swollen balance sheet is worthy, but executing the program through bond markets is tanking global financial markets.
The correlation between financial markets and balance sheets of the Fed and other major central banks is nearly perfect; they drove the markets up during QE and are now driving them down. They should avoid both.
The central banks’ impact on markets is well recognized; as widely respected Blackstone investment strategist Byron Wien has said, “The most important factor influencing the financial markets may be central bank liquidity.”
The second assault on investors is from the Fed’s interest rate increases. Again, its goal to normalize interest rates is commendable, but the Fed already is close to its neutral objective and is threatening further excessive rises.
The third assault on investors is the government shutdown. While past shutdowns have seen stock market gains, current unsettled financial market conditions are aggravated by negatives such as the threat of a long stand-off.
The final assault on investors is the China trade dispute. While trade is a relatively small part of the U.S. economy and the Chinese government has diminished U.S. financial market involvement, as with the shutdown, any potentially negative factor is magnified during unsettled conditions.
The federal government must adopt the following New Year’s resolutions:
If the Fed chairmanship of (my former investment banking colleague) Jerome Powell is to mean anything, it should be the application of common sense and judgement from his decades of financial market experience.
When the Fed began its QT program, its negative effects were obscured by spillover from the European Central Bank’s continued stimulus, but that has now ended and the negative pressure from the Fed’s withdrawal of liquidity has been relentless.
They must suspend the QT program to let the markets settle. As advocated in an Oct. 27 column in The Hill, they should test a program to cancel long-term U.S. Treasury debt held by the Fed and replace it with short-term paper distributed to the Fed’s member banks in lieu of their existing reserve deposits, thus shrinking the Fed’s balance sheet without affecting financial markets or banking system balance sheets.
Similarly, the Fed needs to pause its program of interest rate increases and announce they will be changed only as conditions warrant. Currently, inflation is again below the Fed’s target, the economy is slowing, and the financial markets are a mess, so conditions do not warrant interest rate increases.
It’s hard to believe that both Republicans and Democrats are taking their various electoral successes as policy endorsements. Each election since the Democratic landslide of 2006 has been a rejection of a presidential incumbent, excepting Obama’s 2012 reelection, which, with diminished margin, was hardly a ringing endorsement.
Americans reject the Obama and Trump narrow base-catering policies. The current spat over an infinitesimal portion of the federal budget is being conducted by both parties acting as snotty brats who will take their toys and go home if they don’t get their way.
The American people have a right to expect behavior up to the standards of, say, a fifth-grader, who would know enough to split the difference and move on. Maybe they then could do something productive, like turning around the ever-widening financial hole the U.S. government is in.
The Chinese economy’s morass of wasted investment fueled by skyrocketing debt is fodder for many columns. Suffice to say the Chinese government wishes to maintain U.S. trade.
Teddy Roosevelt, a fellow Republican New Yorker, may provide a good example for Donald Trump. To paraphrasing TR: “Tweet softly and carry a big stick.”
The Chinese know we have a big stick. Now let’s give them space so that a proud nation with a worried leadership can maintain face in coming to an agreement to mend what almost everyone agrees have been egregious trade practices.
The good thing about current investing conditions being so bad is that chances are good for turning them around. Relatively simple measures such as pausing Fed policy, splitting legislative differences and a modicum of diplomacy in trade negotiations will do just that.