Sinking another 392 points to close at 16,514 today, the Dow Jones Industrial average is down 10% from its record close May 19, 2015 of 18,312. While still not in the correction category of 20%, the market’s CBOE VIX or market volatility index hit 24.77, less than other sell offs, hitting 37 in Aug. 2015. Today’s sell-off has more to do with over-valuation and profit-taking, putting the market on the right foot in 2016. Without the sell-off market had nowhere to go but down, especially given economic slowdowns in China and Europe. Deciding to raise the Federal Funds rate 25 basis points Dec. 16, Federal Reserve Board Chairman Janet Yellen hoped for the best, especially about consumers spending before the Christmas holiday. Yellen’s interest rate hike couldn’t have come at a worse time with the nation’s inflation rate remaining under one percent, a sign of possible deflation.
Urging Yellen to hold off on hiking rates, International Monetary Fund Managing Director Christine Legarde warned the Fed about tinkering with the global economy. Yellen’s projections of U.S. Gross Domestic Product growth stem from expectations about consumer spending, something vexing the Fed. With the U.S. unemployment rate dropping to 5%, Yellen and her Open Market Committee concluded that consumer spending looked poised to pick up, fueling an expected 2.5% GDP growth. Legarde wanted Yellen to wait on raising rates until China sees an upturn in manufacturing. With Europe and the U.S. unlikely to spur enough consumer spending, demand for Chinese manufacturing could remain anemic for sometime, keeping the inflation rate suppressed. Yellen and FOMC governors thought that lower unemployment would lead to more inflation and GDP growth.
Watching markets sell-off, some economists see no justification based on the Labor and Commerce Department’s data showing the economy continuing to add some 220,000 jobs a month. Outplacement firm Challenger, Gray and Christmas sees no evidence of job layoffs in publicly traded companies, also indicating increases in consumer spending, accounting for about two-thirds of the nation’s GDP. Fed economists note record auto sales in 2015 as a sign that consumers have taken out their wallets. Domestic carmakers like Ford and General Motors have practically stood on their heads to make deals, leaving both companies with the thinnest profit margins in Detroit’s history. While there’s been some improvement in residential and commercial real estate sales, overly strict lending standards have locked out the vast majority of real estate buyers.
China’s ongoing stock market sell-off, dropping the Shanghai Composite Index from a high in June 2015 of 5,000 to today’s close of 3,125, a whopping drop 38%, causing a cash-flow crunch going forward in Chinese industry. Expecting consumer demand to improve in China anytime soon doesn’t match China’s stock market entrepreneurs that have dumped stocks. When you consider the slowdown in Europe added with the immigration crisis, it’s going to take some time before European consumers jump back on the bandwagon. “As far as the domestic economy is concerned, we see growth continuing,” Wells Fargo wrote in a newsletter to clients. “Downside volatility caused by fear and uncertainty creates buying opportunities, in our opinion,” wrote Wells Fargo, stating the obvious that stock market corrections create buying opportunities for savvy investors.
No one knows how low market will eventually go. Dropping 10% since May, the Dow Jones Industrial Average, Nasdaq Composite and S&P 500, have all dropped well below their three-month moving averages, suggesting that the sell-off could continue. Dropping to 12-year lows, the price of crude oil showed more weakness, ending today at $33 a barrel. Today’s collapse of world oil prices slows economies all over the globe, especially in the Mideast and Russia. No one forecasting the U.S. economy can ignore the global oil price collapse, expected to continue dropping once Iran begins to sell crude oil in world markets. Growing tar-sands oil industries in Canada and the U.S. have been hurt by the collapse of world oil prices. Slowdowns in the tar-sands oil markets in the U.S. and Canada hurt consumer spending, regardless of what happens with Friday’s Labor Department jobs report.
This week’s sell-off was long overdue, predicted by a number of reputable economists, including Alliance SE chief financial advisor and former PIMCO co-CEO Mohamed el-Erian. Economic weakness in China and Europe have begun to catch up with the U.S., now expecting slower growth in 2016. When Yellen bumped up the Federal Funds rate 25 basis-points Dec. 16, it left Legarde and other economists scratching their heads. Three rounds of government bond-buying known as “quantitative easing” and record low interest rates since 2008 didn’t spur the inflation needed to justify Yellen’s rate hike. Hiking rates only derailed investors, triggering the current sell-off that still hasn’t hit bottom. Neither political party wants to address the net loss of federal jobs in the 2016 election. Shedding more federal jobs hurts the U.S. middle class and slows inflation and U.S. GDP growth.
