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A Week of Investor Whiplash: What’s Behind the Stock Market’s Volatility

February 9, 2018, 1:11 PM UTC

The last week has been a tumultuous time for global markets.

While many of the world’s top movers and shakers were radiating optimism at Davos just a few weeks ago — back when the markets were busy breaking records on the back of U.S. tax cuts — things went south on Friday last week.

Monday was grim. Tuesday was a bit more positive, but the respite was brief. Then the S&P 500 entered official correction territory — 10% or more down from the peak — on Thursday, and Asian indexes plunged on Friday.

So why did this happen?

Wage increases

The drop appeared to be precipitated by the release of U.S. jobs data last Friday, which showed worker pay was increasing significantly. Economists and traders looked at wage inflation and saw the specter of consumer price inflation, which could in turn increase interest rates if it gets too high. Low interest rates are good for stock markets because when cash and bonds are earning little, equities make a more productive home for people’s money.

As Matthew Klein pointed out in the Financial Times, a more context-heavy view sees wage growth actually slowing a little since the second half of 2016. He also noted that in lower-paid sectors, where wage increases tend to lead to higher spending rather than saving, wage growth was definitely slowing down.

In other words, the wage growth is at the higher end of the spectrum, where people tend to save more if they’re earning more. That’s not to say interest-rate fears aren’t behind the slide — just that traders might be misguided.

Volatility unleashed

When the financial crisis hit, the Federal Reserve bought loads of treasury bonds and mortgage-backed securities, essentially pumping money into the financial system. In September last year, feeling that the job as done, it started to unwind this massive “quantitative easing” stimulus program by reducing its $4.5 trillion portfolio.

That spelled the end for a lengthy period of artificially low interest rates and suppressed volatility that’s the only reality younger investors and traders know first-hand. That’s the basis of this analysis from Chad Morganlander, a Washington Crossing Advisors portfolio manager interviewed by Bloomberg:

“The reality is, it’s been 10 years, and a lot of people that are in the market today have had 10 years of a Federal Reserve that has artificially repressed volatility. And as they step away from that, reality starts to kick back in. There’s been a 10-year fantasy land that investors have been living in. And that’s a fairy tale that’s about to end.”

What now?

The big question now is whether this correction turns into a bear market (or, if it does so at speed, a full-on crash.)

There have been 10 corrections in the S&P 500 over the last two decades, and only two led to a bear market — that is, where markets lose at least 20% of their value. Those were the dotcom bust and the Great Recession, where the S&P 500 respectively lost almost half and well over half its value.

The Dow just had its worst week since the financial crisis, but it’s far from clear whether we’re heading into bear territory.

Veteran investor Jim Rogers warned Thursday that the next bear market would hurt because “debt is everywhere, and it’s much, much higher now” than before the last crisis. He didn’t say this was it, though.

On the other hand, economic fundamentals seem strong — which is why the Fed began the rollback of quantitative easing last year. As Independent economics editor Ben Chu wrote earlier this week:

“The stock market is not the economy. Stock markets can boom when GDP is stagnant, when wages are flat, when living standards are going nowhere. And they can fall when economies are picking up speed and life, for many people, is getting better. The latter actually describes the current situation.”

The next few days — and weeks — will show whether the market is a real bear, or just grumpy.