The stock market is calling the White House to account, and it won’t be easily distracted.
The S&P 500 Index has tumbled 19.8 percent from its recent high on Sept. 20 through Monday, just shy of a 20 percent decline that customarily defines a bear market. It’s no doubt a bitter pill for President Donald Trump. He fancies himself a champion of American business and gauges his success by the level of the stock market. With stock prices plummeting, the president can’t feel great about how things are going.
Nor should he. Economists have warned for months that Trump’s trade policies could squeeze American companies’ bottom lines and that recordbudget deficits could hamper the economy, overshadowing the boost from his corporate tax cuts. With every decline, the market is warning the administration that those risks are growing.
Rather than rethink its policies, the White House has turned to its well-worn playbook of distraction and blame. It won’t work. Stocks don’t care much for politics, but they care a lot about stability, the economy and how companies perform. If Trump wants to pacify the market, he will have to address the issues it actually cares about.
After the Federal Reserve raised the federal funds rate as expected on Wednesday, investors are no doubt watching how longer-term interest rates respond. But the stock market’s moves will be just as revealing.
U.S. stocks have been on a historic run since the 2008 financial crisis. The S&P 500 Index has returned 18 percent annually from March 2009 through August, including dividends, making it one of the best decades for stocks since 1926. It’s also the second-longest stretch without a bear market, as defined by a decline of 20 percent or more.
Bulls attribute much of that success to lower interest rates. It’s no coincidence that stocks skyrocketed soon after the Fed dropped rates in late 2008 in response to the financial crisis, they argue, and that the market kept moving higher while the Fed held rates low for years.
The gist of the argument is that investors expect a premium for owning risky stocks rather than safe bonds — in technical jargon, an equity risk premium. When bond yields decline, stocks can pay less, too, provided that the premium stays roughly the same. But there’s little evidence investors are paying attention to the premium.
It’s time for investors to stop fighting the last war. The next downturn most likely won’t be triggered by another meltdown of the financial system.
The Federal Reserve has concluded its stress test of big banks, a look into whether they have enough money set aside to withstand another 2008-type financial crisis. The Fed announced last week that all 35 banks examined are sufficiently capitalized. It disclosedthe second and final round of results on Thursday afternoon, giving all but one bank a passing grade and the go-ahead to return money to shareholders.
Investors didn’t need the Fed to tell them that banks are in better shape than they were a decade ago. The signs are everywhere. Profits have fallen across the industry since the financial crisis, an indication that banks are taking on less risk. Profit margins for the S&P 500 Financials Index averaged 9.3 percent from 2008 to 2017, down from an average of 13.8 percent from 2003 to 2007, the years leading up to the crisis. Return on equity is down to an average of 5.2 percent from 14.5 percent over the same periods.