It was just like the bad old days in financial markets. Screens in dealing rooms turned a sea of red as stock markets plunged in the familiar domino style: first Wall Street, then Asia and finally Europe.
This was the first big share price fall of Donald Trump’s presidency and there was a notable absence of tweeting from the White House boasting about how Americans had their president to thank for booming stock markets. Instead, there was talk of bubbles being burst following a rise of more than 40% in the Dow Jones Industrial Average since Trump defeated Hillary Clinton in November 2016.
But so far what has happened amounts to a correction rather than a crash. The 1100-point drop in the Dow Jones Industrial Average sounds like a lot but in percentage terms it amounted to a decline of less than 5%. On two consecutive days in October 1929, the Dow plunged by first 13% and then 12%. The more broadly-based S&P 500 fell by 86% before hitting the bottom three years later. The record one-day fall for the Dow was a 508-point drop in October 1987, which wiped more than 20% off the value of America’s leading companies. That was a proper stock market crash, albeit a brief one.
The response in the City suggested that investors think the events of the past few days also represent a temporary spasm rather than the start of a sustained bear market. Shares were down sharply at the start of London trading but after a 3% drop the FTSE 100 recovered a bit of the lost ground.
Why are markets down? In part, because they have gone up too far too fast and shares were ripe for a fall. But more importantly, it is because the bull market has been due to the willingness of central banks to supply copious amounts of money to the markets at ultra-low interest rates. Investors fear that era is now coming to an end and that higher inflation will force policy makers to be more aggressive in removing the stimulus that has been provided since the collapse of Lehman Brothers in September 2008.
Memories of the financial crisis have faded. During 2017, stock market volatility was low, investors started to take bigger and bigger bets on borrowed money and speculators discovered a new financial instrument in the form of bitcoin. All these were signs of a reckless overconfidence.
James Bateman of Fidelity International says the stock market correction is a good thing. “The tech-fuelled rally in the US had long lost any sense of reality in its valuations, the prospect of inflation remaining low forever could not last, and we have a new and untested Fed chair,” he says. “It would be more worrying if markets didn’t react to all of this.”
All that is true, and in the short term it is likely that share prices will bounce. Trump has a lot riding on the stock market continuing to rise and certainly did not choose Jerome Powell to be the chairman of the Fed because he thought his appointee was an interest-rate hawk.
The falls on Wall Street were triggered by last week’s labour market report, which showed unemployment at 4.1% and a pick-up in average hourly earnings. But Powell would not have to look all that hard to find reasons for a gradual, market-pleasing, rise in interest rates rather than an aggressive tightening. If the current turmoil continues, Powell will no doubt seek to reassure the markets.
If this all sounds familiar, that’s because it is. During Alan Greenspan’s long reign at the Fed, Wall Street knew that the central bank would ride to the rescue every time share prices plunged. It became known as “the Greenspan put”.
The problem for Powell is that the Greenspan put was ultimately disastrous. It encouraged recklessness, ever bigger bubbles and the crash to end all crashes.