On Monday stocks commemorated the Veteran’s Day holiday with a massive sell-off.
The Dow Jones Industrial Average DJIA, -0.47% plummeted more than 600 points, the S&P 500 Index SPX, -0.43% lost about 2% and the Nasdaq Composite Index COMP, -0.58% shed 200 points. Although none of them are near their lows of earlier this year, they’ve given back a lot of what they gained during a nine-day rally that raised investors’ hopes the October correction was over.
Monday’s action — and Tuesday’s continued losses — dashed those hopes, and raised fears the correction will deepen and become a full-fledged bear market.
I’m still not ready to call it that, though I remain worried about stocks. But now, a surprising new factor is emerging: The U.S. economy’s strength may actually be dragging down our stock market.
U.S. economic growth is so strong the Federal Reserve, alone among major central banks, is simultaneously raising short-term interest rates and reducing its balance sheet by unwinding three rounds of asset purchases that followed the financial crisis.
Those higher rates are attracting investors to our shores, driving up the dollar to recent highs. A strong greenback not only weakens commodities, which are priced in dollars, and the currencies of emerging markets; it also cuts into the profits of U.S.-based multinationals that dominate the Dow and S&P 500.
So far, the Commerce Department estimates U.S. GDP grew 3.5% in the third quarter. That followed 4.2% annual growth in the second quarter, the strongest quarterly GDP growth since the second and third quarters of 2014, when GDP growth averaged 5%.
The International Monetary Fund (IMF) pegs current U.S. annual GDP growth at 2.9%, faster than any developed country except Australia, whose economy is growing at a 3.2% clip. The other big developed economies (Germany, France, Japan and the U.K.) are growing at less than 2%.
Robust U.S. economy
Meanwhile, the U.S.’s unemployment rate has plunged to 3.7%, the lowest it’s been since 1969, during the golden age of the U.S. economy. As labor markets tighten, we’re starting to see wage growth picking up, after years of stagnation. In October, hourly earnings grew at a 3.1% annual rate.
This has allowed Fed Chairman Jay Powell to continue, even accelerate, his predecessor Janet Yellen’s policy of “gradual” increases in short-term rates. By December, the rate-setting Federal Open Market Committee (FOMC) will likely have raised the federal funds rate four times in 2018, but it would still be barely over 2%. It would take three more rate hikes next year to get the rate to 3%, far below the 5.25% it hit after the last Fed tightening cycle, in 2006. Meanwhile, the Fed is trying to sell up to $50 billion a month of securities it bought in its three rounds of “quantitative easing” after the financial crisis.
Together, this constitutes double-barreled tightening, which no other major central bank of a developed country is pursuing. The European Central Bank (ECB) is just ending asset purchases and probably won’t raise rates until at least next September. The Bank of Japan continues to stimulate that country’s stagnant economy, while the People’s Bank of China has put a hold on rate hikes amid economic weakness and trade tensions with the U.S.
Result: The U.S. Dollar Index DXY, +0.05% which tracks the dollar’s performance against other major currencies, has shot up by more than 10% since its February lows, trading above 97, its highest level in a year. The strong dollar has hit emerging economies hard, as companies and countries need to fork over more of their local currency to pay back debt denominated in stronger dollars. (Higher rates also make it more expensive for them to refinance maturing debt.)
The dollar’s strength also has pummeled commodities like oil: Light sweet crude futures have fallen more than 20% since early October, perhaps also signaling some weakness in the global economy, especially China.
In 2017, S&P 500 companies got 43.5% of their sales from outside the U.S. Technology companies derived 57% of their revenues from overseas. A stronger dollar makes American-made goods more expensive when they’re sold abroad, and U.S. companies face the tough choice between lower profits and losing market share. So, it’s no wonder that during their recent third-quarter conference calls, managements cited the strong dollar as a headwind to earnings more often than they did tariffs or trade.
How deep will this go? It depends on how long the U.S. economy and dollar remain strong. By raising rates and reducing its balance sheet even at its current, “gradual” pace, the Fed may wind up weakening instead of strengthening the economy and markets. It could be just one of many unintended consequences of a strong U.S. economy that may now be hurting, rather than helping, our stock market.
Howard R. Gold is a MarketWatch columnist and founder and editor of GoldenEgg Investing, which offers exclusive market commentary and simple, low-cost, low-risk retirement investing plans. Follow him on Twitter @howardrgold.
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