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Financial Nightmare before Christmas

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Published 11th February 2019.
Could saying there's no need to panic when no one is panicking induce a panic?

2018 was a strange year for most, for the stock market it has been the one of the worse in recent memory. The year saw composites for the US stock market such as the Dow-Jones Industrial Average, S&P 500 and the NASDAQ Composite all fall by 5.63%, 6.24% and 3.88% over the year respectfully. Here in the UK, fears of Brexit only grew over the year causing the FTSE 100, to fall by 12.48% as well as the FTSE 250 which fell by 15.56%. The US stock market has seen a volatile year and December didn’t disappoint.

This December alone saw the Dow-Jones fall by 8.66%. The S&P 500 fell by 9.18% which made this the worst December for the index since 1931.

CHANGE IN STOCKS

Christmas Eve saw the biggest fall during the last trading day before Christmas on record for the Dow and S&P 500 which saw declines of 2.91% and 2.71%. Before 2018 the S&P 500 had never seen a fall of more than 1% on its last day of trading before Christmas since being created in 1923. The NASDAQ wasn’t safe from Christmas Eve itself, falling by 2.21%.

BEAR MARKETS

A Bear Market, opposite to a Bull Market, is a term for when a security’s price falls 20% from its highest, over a sustained period of over two months (if less it would be considered a correction). A Bear Market is often a sign that prices are more likely to continue falling and encourages divestment. It’s usually caused by investor pessimism or scepticism in the profitability and growth of a security, which can be caused by political or market changes, etc. For instance, the trade war between China and the USA recently forced China’s stock market into a bear market this Summer.

After Christmas Eve, how were the US indexes doing? Well, the S&P 500 was down 19.78% from its high in September, painfully close to being officially deemed a bear market. The Dow was down 18.77% from its high in October., with the NASDAQ Composite deep into a bear market 23.64% from its high in August.

Here in the UK the FTSE 250, which had seen highs earlier in the year to 21,318.77 points on June 11th, has declined opening at 17,442.98 and closing at 17,312.18 on the 24th. This is less than a 1% drop, but this has continued the downward spiral seen for the last six months. The FTSE 250 is less than 2% off a bear market, 18.81% down from its June 11th high. While the FTSE 100, which was valued at £2 Trillion at the start of the year, has seen the same trends having closed down 15.13% from its May high.

With all of these indexes falling, however, there must be some kind of linked cause. There was two pieces of news that seemed to make investors anxious. The particular shifts we were seeing in the US stock-market suggests that there was something there, so what happened before Christmas Eve?

CONFUSING MESSAGES FROM THE TREASURY

Steve Mnuchin is the current Secretary of the of the United States Treasury Department, as of writing this. On the afternoon of the 23rd of December, the Treasury released a statement that reads:

“Secretary Mnuchin conducted a series of calls today with the CEOs of the nation’s six largest banks […] The CEOs confirmed that they have ample liquidity available for lending to consumer, business markets, and all other market operations. He also confirmed that they have ample liquidity available for lending to consumer, business markets, and all other market operations”

I’ll give a second for those that remember the financial troubles between 2007-8 to shudder. If you’re feeling confused, I’ll add that by August in 2007 the Federal Reserve acknowledged the fact that banks didn’t have enough liquidity to function, to the point where the Federal Reserve started buying subprime mortgages from the banks to increase their liquidity later that same year.

To which you might think “well the same economic problems that led there aren’t present now. We don’t have another Sub-Prime Mortgage Crisis, we don’t have a housing slowdown, etc.” and you’d be right, but that’s what’s most worrying.

As American statistician Nate Silver put: “Could saying there’s no need to panic when no one is panicking induce a panic?”. The implication of the letter that we should be prepared for a financial crash like that of 2008 rightfully made investors and economists nervous.

Winner of the Nobel Prize in Economic Sciences, Paul Krugman wrote on twitter:

“This is amazing. It’s as if Mnuchin was trying to create a panic over something nobody was worried about until this release […]

You know, nobody seriously trying to think about the economic risks is envisioning a replay of 2008; the problems now are much less bank-centred, much more about trade and lack of monetary space. But *maybe Mnuchin doesn’t know that* — and maybe nobody in the admin does.

We should take seriously the possibility that we’re looking at an economic team as clueless as their boss — and that they’ll respond to real problems by firing off off-point tweets from various golf courses”

The topic of The President and golf leads into the other cause for the indexes sliding on the 24th…

PRESIDENT TAKES AIM ON THE FEDERAL RESERVE

Also, from DC, two actions came from Trump that made investors anxious, both to do with the Federal Reserve. Firstly, we found out that Trump recently discussed firing Jerome Powell, Chair of the Federal Reserve. Secondly, early on the 24th, President Donald Trump tweeted:

This causing fear of further political and market instability, if able to push the Chair to resign, the President would change the priorities of the Federal Reserve in directions that investors don’t know yet.

AFTERMATH

In a year known for its volatility after sinking to bear market lows, how did the indexes behave in the time between Christmas and New Years?

In the US, the stock market rebounded. The S&P 500 and the Dow were up by 4.96% and 4.98% with the latter gaining 1086 points which is its largest ever single day gain. The previously sinking NASDAQ raised 5.84%. Speaking to CNN, Chris Rupkey, the managing director of Mitsubishi UFJ Financial Group said “Investors went bargain shopping the day after Christmas, where stocks just got too cheap relative to earnings, future earnings, any reasonable assessment of earnings […] The coast is clear, back up the truck, investors are saying enough already, the world is not ending”

Furthermore, the US and Chinese stock markets have both responded positively to the news of possible trade talks to end the US-China trade war.

Meanwhile in the UK, the FTSE 100 & 250 didn’t surge as the US market did, each falling more than 1% when the trading closed on the 27th, losses that were recovered before New Year’s. Could this be the start of a reinvigoration for stocks worldwide? Or will the volatility we saw last year continue into 2019? Aspiring and current actuaries should keep an eye on this.