What Today’s Stock Drop Says About the Economy

Another day, another loser in the market. At least that’s how it feels. The Dow Jones industrial average dropped 265 points, and now stands at just under 10,400. Yesterday, the Federal Reserve said that it plans to buy more Treasury Bonds in an effort to continue to stimulate the economy. And if the economy needs stimulating then everyone guesses it must still be pretty weak. Surprisingly, in good times, Fed moves like this one can boost the stock market. But these are not good times. So the stock market falls. As Barry Ritholtz says look out below.

But the question is just how bad a times are these. The stock market is usually a pretty good forward indicator of where the economy is headed. So the recent market drops must mean we’re again headed for rough economic times, right? Not necessarily. Here’s why:

The main reason is that the market is not as bad as it seems. The problem like in poker is that we only remember the losing hands, the bad beats, or in investing the days when the market is down. Surprisingly enough we tend to forget the good days. Looking at another down day today, I though for sure we had hit some record on the number of days with market drops this year. Not even close. So far in 2010, the market has been down 200 points or more 11 days, including today. How does that compare to other years?

The market fell 200 points or more 15 times in 2009. So we are on pace to beat that. But we are not even close to the number of down days in 2008. That year the market had 49 days in which the market fell 200 points or more. In fact, this year the number of down days has roughly equaled the number of up days. As for 200 point plus days, we are only slightly in the negative column. The market has been up 200 points or more on 8 days, only three less than the number of days it has been down that much. Overall, the Dow Jones Industrial Average is down less than a percentage for the year.

So what does all this mean? I’m not exactly sure. But what it may mean is that the economy is not as doomed as today’s drop suggests. In part, the Fed’s move is window dressing and investors signaled to the Fed that they know that. The Fed will use federal dollars to buy debt that is being issued by the Treasury. So we are using our dollars to buy our own debt. In theory, it should stimulate the economy by increasing the money supply, but it is a little bit of just reshuffling the deck. And in the end it won’t do nearly as much as if Washington passed a new stimulus bill, or even cut taxes.

The real long-term problem is the growing consensus that the stock market is a no-win game. Megan McArdle has a story in the current Atlantic saying that stock market returns may never return to what we have come to expect of them. Part of what propels stocks is confidence that they will do better than other investments. That’s what created the equity premium in the 1980s and 1990s. And that has slowly slipped away. That’s bad news for the stock market. But it might not say anything about the economy.

Facebook, Wall Street Banks Sued Over Pre-IPO Financial Forecasts

Just days after its controversial IPO, Facebook and its Wall Street bankers have been hit by shareholder lawsuits alleging that the social networking giant and its underwriters concealed the company’s decelerating revenue growth from investors. The lawsuits come amid a growing furor about whether Facebook’s banks selectively disclosed information that gave favored clients an unfair advantage over other investors. Top U.S. regulators have begun examining the IPO, and now the U.S. Senate Banking Committee and other lawmakers want answers from Facebook about issues raised in the offering’s aftermath, according to The Hill newspaper.

Small Dairies Go Under as Milk Prices Sink Again

PLAINFIELD, Vt. — The MacLaren brothers are third-generation dairy farmers, but they will likely be the last in their family.

After working all their lives on the hillside farm in Vermont that their grandfather bought in 1939, rising to milk cows at 3 a.m., even in blizzards and sub-zero temperatures, they decided to call it quits, auctioning off their roughly 200 cows and equipment ranging from stalls and hoof trimmers to tractors and steel pails.

deconstructiva

Stephen, it’s interesting to compare your post here, esp. last paragraph, with Barbara’s last one on low interest rates. Do YOU (and your teammates, sources, crystal ball, tarot cards, etc.) think stocks, even as volatile as they are, can still beat traditional savings with their crappy low rates? (No, I’m not asking for stock picks, our situations are all unique, just an overall analysis.) A big question now would be choosing (or not) dividend-paying stocks vs. relying on price appreciation alone. I’d bet on dividends for now with no clear trend yet for a growing recovery. Thanks for your thoughts.
tanboontee

Never mind how unstable and fragile the Dow has been lately. The fact is we are already in the early stage of a double-dip. Whether the western economy will totally collapse or not remains to be seen, even though it might not be that soon.

We must have been overtly if not unnecessarily pretentious.
pneogy

“That’s what created the equity premium in the 1980s and 1990s. And that has slowly slipped away. That’s bad news for the stock market. But it might not say anything about the economy.”

I am not quite sure what the equity premium is (some sort of inverse risk premium?). If you look at the ten year bond yield, the current risk premium is indeed huge. And that is understandable given the recent economic performance and the economic uncertainty going forward. In that sense the risk premium says plenty about the economy. Once investors have some assurance that the economy is performing as expected, the risk premium will come down.