Down Down The Dow Jones Goes Down16/02/18
Newly appointed Publications Officer Heath Gabbett discusses the recent turmoil in the stock markets in this week’s edition of The Take:
The American Dow Jones Index, which tracks the share price of 30 of the most prominent American companies, fell 4.6% on Monday and the aftershocks have been resonating around the world.
Many commentators have suggested that a correction in the market was long overdue. Despite an economy that was still recovering from the GFC, American investors pushed the Dow Jones to record levels in 2013 – and the market continued to climb. The market then reached a peak in late January, before falling more than 2000 points, including over 1100 on Monday.
That fall of 1175 points is the most substantial point fall in Dow Jones history – but far from the biggest in percentage terms. A decrease in the market by 4.6% occurs regularly – typically around three times per year – but the Dow Jones had gone an unprecedented 312-day streak without a 5% pullback. The end of this streak, paired with the sensationalist headline of the biggest fall ever, lead to the Dow Jones’ fall causing ripples around world markets. The Australian ASX 200 fell over 3%, the Japanese Nikkei Index was down 4.73%, and the Shanghai Composite likewise fell over 3%.
Experts have found several reasons to justify the crash in the Dow Jones, most of which centring on the pullback of Federal Government quantitative easing in the United States. After the GFC, the US Federal Reserve took drastic steps to keep the economy afloat. They first dropped interest rates to zero, before beginning a quantitative easing policy – essentially printing and ejecting $US3 trillion into the economy. Europe and Japan followed suit, employing equally low-interest rates alongside quantitative easing. Around $US20 trillion was generated by these policies, and much of it flooded into the stock market, inflating prices to record highs. With money cheaply available, and interest rates from traditional savings so low, investors flocked to stocks more and more. Until very recently, the Dow Jones was trading at a Price/Earnings ratio of over 25, compared to the rate of about 15 it typically sits at. It was clear from all indications that the market was overcooked.
With low-interest rates underpinning the market surge, it made sense that rising interest rates would result in its fall. The US interest rate began to grow in late 2016 and was further lifted three times in 2017. While US interest rates are currently at 1.25-1.5% a member of the Federal Reserve’s rate-setting committee, Robert Kaplan, indicated that they could rise a further 0.75 percentage points in 2018. The reduced stimulus for the economy and the promise of further reductions was enough to set off the decline in the Dow Jones. The market may just have further to fall before all is said and done.
While the crash in the American market may be justified, there is less reason for concern in Australia. Firstly, while US interest rates reached as low as 0%, Australia’s cash rate has not reached lower than 1.5%. Further, while the US Federal Reserve printed more money with its quantitative easing policy (as did Europe and Japan), Australia stuck to conventional monetary policy. Finally, while the Dow Jones reached earnings multiples of over 25 before the crash, the ASX 200 is sitting comfortably at a PE Ratio of about 16 – not far off the long-term average. So while experts believe the Dow Jones may have further to fall, the news might not be as detrimental for the Australian share market.
The correction in the Dow Jones and global markets provides an interesting case study on the impact of monetary policy on share markets. As reserve banks continue to cut back on their expansionary policy, it will become more expensive to invest and to save money with banks will again become a viable option. This shift will continue to put downward pressure on the market. So while the Dow Jones’ recent fall is indeed interesting news, it is more than likely not over yet.