By Dr. Mike Walden
I’m fond of telling this story about the late Nobel Prize-winning economist Milton Friedman. At one of his public lectures, Friedman was asked to give a forecast for the stock market. Before answering, the heralded economist said he had developed a model for predicting the stock market, and he had recently re-calibrated the model using the latest information. Therefore he had fresh forecasts.
There was a hush over the audience as they eagerly awaited the famous academic’s answer. With a slight smile, Friedman clearly stated – “my forecast for the stock market over the next year is – the market will fluctuate!”
Friedman’s point was the stock market is virtually impossible to accurately predict with any consistency. Some may forecast the market correctly for a couple of years, only to be disappointed thereafter. So many factors impact the stock market, and so many investors interpret those factors differently that flipping a coin might be the best – and cheapest – form of crystal ball.
We only have to look at last year to find support for this point. In 2017 the stock market sailed happily along, setting new highs almost daily. At the end of the year Congress passed – and the President signed – a new tax bill that most experts said was very generous to businesses and investors. Thus, it seemed as if the stage was set for more stock market gains in 2018.
But so far it hasn’t happened. Indeed, the opposite has occurred. The stock market has been in a “correction” – meaning a decline of over 10 percent – for most of the year. Milton Friedman’s great insight is still with us.
Although economists and other financial analysts may have trouble predicting the stock market’s future, I jokingly tell my audiences we are better at predicting the stock market’s past! It is always easy to look back – with the benefit of hindsight – and find factors that pushed the stock market up or down.
Looking back now, it appears there are two i’s and two t’s bothering investors. The two i’s are inflation and interest rates, and the two t’s are trade and technology.
For most of the last decade, inflation and interest rates have been low – actually super-low. From 2008 to 2016, the average increase in all consumer prices was only 1.1 percent each year. In fact, the Federal Reserve worried the inflation rate was too low, fearing consumers would have no urgency to buy today before prices rose. Some even blamed the sluggish pace of economic growth on low inflation.
Interest rates were also so low that it was commonly said money was free – meaning it cost very little to borrow money. Interest rates on money market funds – a type of short-term investment, were barely above zero, and mortgage rates paid to borrow money for a home purchase fell close to 3.5 percent, the lowest since I’ve been alive (1951).
These low rates helped businesses by making borrowing cheap and keeping costs in line, and they funneled investors’ money into the stock market because that was almost the only place to make good returns.
But now inflation is bubbling higher. In the last two years annual gains in consumer prices have averaged 2.2 percent – still low by historical standards but double what it had been. Interest rates are also marching higher. Suddenly businesses are worried about their costs of borrowing and their ability to pass on higher costs to consumers. The future now looks more challenging to investors in the stock market.
The first T shoe dropped a month ago when the Trump Administration announced selective tariffs on imported steel and aluminum, with the focus being on China. Recently China responded with tariffs on 128 U.S. exports, including – most notably for North Carolina – exported meat. With over 25 percent of the U.S. economy involved in international trade via exporting or importing, investors worry a “trade war” – where countries respond to other’s tariffs by imposing their own tariffs – could occur and sink the world economy into recession.
Worries stemming from the second T – technology – are based on both of its largest components – social media and internet buying. The social media world was recently rocked by revelations about the use of personal data stored on the largest site – Facebook. Some are now calling for such sites to be regulated by the government, and investors are concerned about what this might mean. There have also been new criticisms leveled against the largest internet buying site – Amazon – over claims the company is not paying its fair share of sales taxes.
The implication is two of the biggest components of the technology sector that have contributed to stock market gains now have some questions about their futures.
I was taught in grade school to always make sure I crossed the i’s and dotted the t’s in my handwriting. Today we have two i’s and two t’s driving the stock market. Do we know where? Would someone as smart as Milton Friedman even know? You decide!
Walden is a William Neal Reynolds Distinguished Professor and Extension Economist in the Department of Agricultural and Resource Economics at North Carolina State University who teaches and writes on personal finance, economic outlook, and public policy.