Giving an X-Ray into Wall Street’s practices, the Dow Jones Industrial Average plummeted 1,486 points or 4.84% of its value to near 24,400, only to watch it bounce like Silly Putty to 2,500 instantly, showing the how fund traders control sell offs. Average investors in pension funds, 401Ks or IRAs can only take a deep breath watching portfolios lose 5% of overnight. University of Pennsylvania’s Warton School economists Jeremy Siegel hoped the recent sell off, nearing a 10% correction, would help wring speculators out of the market. While that’s a nice fantasy, Wall Street is built on speculators, riding the ups-and-downs, buying on dips and selling on peaks. Over the last five sessions, the nation’s biggest funds took profits from the spectacular profits since President Donald Trump won the election Nov. 8, 2016. Climbing from 18,332 Nov. 8, 2016 to its high Jan. 26, 2018 of 26,342 or over 40%, a correction was due.
Locking down profits after spectacular run-ups is the usual-and-customary way funds take profits. Talking about rising interest rates, domestic political squabbles or geopolitical events are all excuses for Wall Street to take profits. When precious metals don’t go up, it signifies profit-taking as oppose to something more fundamental, including a shift from a bull to a bear market. With the Trump tax cuts firmly in place, most Wall Street expectations are for stronger earnings growth, something that propels higher stock valuations. Before small investors panic, they should consider market fundamentals, all in place to see the nation’s GDP grow at about 3% in 2018. Newly minted Federal Reserve Board Chairman Jerome Powell expects to hike the Federal Funds Rate three times to 0.75% or to 2.25% over the year, possibly a fourth hike to 2.5% if inflation heats up.
Small investors have a tendency to panic when Wall Street takes periodic profits. Rocketing up over 40% since the Nov. 8 elections, investors can afford to give back 10% in the short-term, knowing, after fund traders decide a near-term bottom,, market will rise again, most likely to hit new records highs in weeks or months to come. Only when market fundamentals change, including a drop in jobs creation or an up-tick in the current 4.1%, 17-year-low in unemployment rate. When gold starts to spike, there’s a belief by analysts that the bull market’s started to unwind. There’s no sign of that in today’s profit-taking, dropping the Dow 1,175 points or 4.6%, it’s not going to drop much further. Yet Harvard economist and best-selling author economist Martin Feldstein forecasts that major market averages could tumble up to 30% given the Fed’s new tightening stand on interest rates
With gold rising only 2.70 or 0.20%, it’s doubtful that today’s sell off is anything other than cyclical profit-taking. “We’re always concerned when the market loses value, but we’re also confident in the economy’s fundamentals,” said CNBC’s Eamon Javers, cautioning small investors to not panic. Traders were concerned about when the 10-year treasury bond hit 2.85%, expanding the spread between long and short-term rates. Only a few weeks ago traders were concerned when the yield curve flattened or started to invert, when the 10-year bond got closer to the one-year treasury at 1.86%, nearly a point lower than the 10-year bond. When the 10-year bond goes higher it signals an economy heating up, not heading toward recession. With an expanding economy comes higher interest rates, something priced into share prices. Investors also questioned whether Trump’s tax cuts would balloon federal budget deficits.
Looking for rational explanations to the current sell off doesn’t take into account how the nation’s biggest funds lock-down profits through periodic sell offs. No matter how painful for investors to watch markets plummet, cyclical profit taking is a way of life on Wall Street. “The issue is, did tax reform kill the bull market or is tax reform a fiscal policy mistake? That’s what the market is struggling with,” said Nicholas Coles, co-founder of DataTrek Research. Deficit hawks in Congress worry that Trump’s tax cuts could balloon the deficit, causing a precipitous drop in government tax revenues. Backers of tax reform expect a booming economy to reduce deficits, something that didn’t happen the last time the GOP passed tax reform in 1986, toward the end of President Ronald Reagan’s last term. But whether that’s all relevant, major funds still take profits when markets hit new peaks.
Whether or not today’s 1,500 drop in the Dow represents an inter-day bottom is anyone’s guess. Predicting market bottoms or tops isn’t easy. Most economic data from the Fed all point toward strong economic growth with GDP expected in 2018 at over 3%. If newly minted Fed Chairman Powell ratchets up rates too fast, he can expect more volatility in equities. One major geopolitical event could trigger more selling on Wall Street, potentially leading to recession. Instead to guaranteeing more rate hikes, Powell should wait and see before hiking the Federal Funds rate. If rate hikes continue to slam stocks over the long run, as suggested by Feldstein, Powell could inadvertently plunge the economy into recession. Trump’s corporate tax cuts don’t necessarily trickle down to ordinary consumers. If consumers start to belt-tighten, it could spell trouble for U.S. GDP in 2018.
