Early Tuesday morning, as global stock markets plummeted on fears of a U.S. economic recession, the U.S. Federal Reserve made an unscheduled adjustment to the key federal funds interest rate, lowering it three-quarters of a point to 3.5 percent. The action, however, was not enough to calm equity markets, with the Dow Jones dropping more than 120 points on the day and closing below 12,000. Markets are volatile. Recession — though not in the data — is certainly in the air. What should investors think? National Review Online’s resident financial experts have some answers.
People who believed in the Bush boom and got into the markets when the president cut tax rates in 2003 have done very well. If you read NRO and have bought into the ideas of Larry Kudlow, Art Laffer, Steve Forbes, Rich Karlgaard, Brian Wesbury, Don Luskin, and yours truly, you made money. If you bought into the leftie doom-and-gloom scenario of Paul Krugman et al, you missed one of the great wealth-creation events in modern history. Bush proved, once again, that Reaganomics isn’t just theory — it really works. It works when Republicans like Calvin Coolidge use it. It works when Democrats like JFK and Bill Clinton use it. It even works when Russia and China use it.
But it doesn’t work when it’s not used, and that’s what’s happening to investors right now.
There’s been a great deal of discussion about whether or not the Bush tax cuts are going to expire at the end of 2010. But almost nobody has mentioned the fact that some of them have already begun to expire. The tax cut of 2003 extended a provision which changed the law (for fellow code-heads like myself, I’m talking about section 179) so that businesses could deduct durable-equipment expenses more quickly than had been allowed previously. Instead of forcing businesses to spread the tax deductions out over five or seven years, they were given greater leeway to deduct the purchases at the time they were made. That provision expired three weeks ago. No wonder investors are apprehensive about a slowing economy.
It’s not just the business-equipment deduction; it’s also the whole cluster of issues that buzz around the presidential election. Every caucus and primary election is a leading indicator of future tax and regulatory policy. Investors are just registering what they see. And they see that since Iowa, the pro-growth party has been in disarray while the anti-growth party has been the beneficiary.
If you don’t believe me, just look at the Intrade political-futures market for a Republican win overlaid with the Dow Jones Industrial Average. As the GOP prospects fall, so do the prospects of the investor class. Either a pro-growth candidate becomes a front-runner, or a front-runner becomes (persuasively) pro-growth. Otherwise investors will remain jittery. Do you blame them?
– Jerry Bowyer is the chief economist of Benchmark Financial Network.
During market downdrafts, investors get the urge to do something. However, this is one of the biggest mistakes they can make. When investors increase their cash exposure during short-run market corrections, they lock in losses and insure that they will not participate in the upside as markets recover. The U.S. experience during the last few financial crises bears this out. Looking back, I can point to Black Monday in 1987, the Mexican peso crisis (1994), the Asian Tigers crisis (1997), and the Russian default crisis (1998) as periods when a market tumble was made back in short order. The investors who held their positions were the ones who came out whole.
From a policy perspective, the current episode suggests that the Fed is ready to provide necessary liquidity while remaining vigilant of the underlying inflation rate. Looking back at prior market turbulence, the Resolution Trust Corp. episode of the early 1990s (an exception to the modern-day rule of quick market recoveries) shows that monetary policy alone may not overcome fiscal-policy mistakes. Recall that President George H.W. Bush raised tax rates around that time, and the economy went into a recession. The proper policy would have been a tax-rate cut. This would have increased after-tax cash flows and asset values, both of which would have accelerated the economic and financial recovery.
Stock market corrections and economic recessions come and go. It’s the nature of a free economy. Add to that Schumpeterian gales of creative destruction, as technological advances bring down old industries in favor of new ones. Turbulence is part of capitalism. But Tuesday’s turbulence should not dissuade investors from buying stocks for the long-run.
This strategy essentially argues for investing in America, which has produced the greatest prosperity in the history of history. I do not see this changing. Right now the stock markets have corrected by roughly 20 percent — the first time in about five years that we’ve had a true correction. To me this means there are a lot of bargains out there. In fact, the market averages at these levels represent good bargain prices.
I always recommend buying broad stock market indexes. For example, the Dow Jones Wilshire 5000 or the S&P 500. Owning international indexes also makes sense, including emerging-market indexes. A package like this gives investors good diversification, keeps it simple, and covers the world.
I don’t foresee the overthrow of free-market capitalism, and not even Senator Clinton will bring back state-run socialism. Folks who bought the market in late 1987 and held it for twenty years did extremely well. I don’t recommend timing the cycles, and certainly not trading on a daily or short-term basis. The idea is to stay long-term. Younger investors should be 100 percent in stocks. Middle-aged investors should be about 80 percent in stocks. And elderly investors should probably be about 50/50 between stocks and bonds.
Be invested. Be diversified. Use cheap exchange-traded fund indexes. And stay optimistic.
Donald L. Luskin
Should we panic? The answer to that question is always “no” — in investing as in life, panic just keeps you from making smart decisions. In markets, panic offers unique opportunities for those who can keep their heads while those around them are losing theirs. And that’s just what those around us are doing. The so-called crisis in subprime mortgages is actually a very small economic problem in the scheme of things — equivalent in its dollar impact to the cost of reconstructing after Hurricane Katrina. Expensive and regrettable, and a tragedy for those directly involved, but really nothing in the context of our massive economy. The scare on Wall Street about exotic debt instruments related to subprime mortgages is just that — a scare on Wall Street. Some big firms and some big players are going to take some big losses, but that’s why (usually) they make the big bucks. None of this ought to throw the U.S. into a recession. All the fear that’s abroad in the land may result in a brief slowdown, but actual recessions only occur when interest rates get so high as to crush economic activity. In this business cycle they’ve never gotten high, and right now they’re headed lower. So don’t panic. This is an opportunity!
– Donald L. Luskin is chief investment officer at Trend Macrolytics LLC.
The Fed rate cuts will have some positive impact on the economy by lowering LIBOR, mortgage, and other benchmark interest rates. The Washington fiscal-stimulus package, however, will have minimal impact because it is temporary and demand-side oriented. There was no mention in Washington of the need for a stronger dollar. This is the single most important step in rebuilding liquidity and causing a recovery.
The U.S. economy has been in a sharp slowdown since the August breakdown of the securitization process, but data on jobs and output remain above recession levels. Balance-sheet losses at banks and financial firms do not by themselves cause losses in GDP or in GDP-related corporate earnings. I think the losses on balance sheets, while severe and growing, will not by themselves cause the deep recession that is already priced into the Treasury market.
– David Malpass is the chief economist for Bear, Stearns.
If I knew what the markets would do in the future, I’d be sitting on the beach in Grand Cayman enjoying immense wealth. But I can confidently state that the White House rebate scheme won’t work to rectify matters, just as Keynesian-type rebate checks didn’t work in the 1970s and in 2001.
When the government distributes rebate checks, it hopes to boost consumer spending. But this analysis ignores the fact that the government must first borrow that money, so any additional consumption spending is offset by lower investment spending. Rebates are akin to taking money from one pocket and putting it another. They redistribute how national income is allocated, but they don’t increase the level of national income. Permanent reductions in marginal tax rates on productive behavior are the way to boost national income, both in the short- and long-run.
I’m also worried about the Fed’s easy-money policy. Not only will it be similarly ineffective (sort of like pushing on a string), but it was the Fed’s easy-money policy of the recent past — which artificially lowered interest rates and lured people into making unwise choices — that is largely responsible for the current market volatility. To avoid the risk of slipping back into 1970s-style monetary policy, the Fed should focus on price stability rather than risky efforts to fine-tune the economy.
– Daniel J. Mitchell is a senior fellow with the Cato Institute.
The recent global equity-market decline is a result of rising recession expectations in the U.S. and the apparent weak government response to those fears. But the Fed’s 75 basis point cut to the fed funds rate Tuesday and a pending fiscal stimulus package from Washington should reverse the emotional market sell-off. (For the fiscal package to best promote consumer optimism, it should contain tax-rate cuts, especially cuts to corporate tax rates.) Some global coordination of government stimulus actions will also help calm nervous investors.
That said, I don’t see any reason for a pronounced global economic downturn. Non-financial corporations remain cash rich and continue to show good earnings growth. The media has contributed to the increased market volatility by encouraging emotional decision-making that is not based on the underlying fundamentals. But these periodic corrections are necessary in that they reduce speculative excesses.
The current correction is not unusual, except for the fact that a new global marketplace also reflects the emotionalism that forces markets to fall. History is replete with examples of market declines that flushed out the speculators and left long-term investors in a position to capitalize on those sell-offs.
– Thomas E. Nugent is executive vice president and chief investment officer of PlanMember Advisors, Inc., and principal of Victoria Capital Management, Inc.